Index

The S&P 500 index (SNPINDEX: ^GSPC) is trading near all-time highs. Since the Vanguard S&P 500 Index ETF (VOO 0.60%) tracks the S&P 500, it is also trading near all-time highs. And it could still be a smart move to buy the index via an investment in the exchange-traded fund.

But there might be a smarter choice, if you take valuations into consideration. Which is where another Vanguard exchange-traded fund (ETF) comes into play. Here’s what you need to know.

Just get started

One of the biggest things any investor can do is get started. So if you have $1,000 to invest and you’ve never done so before, it could be a very good idea to just buy the market. By default, that would be the S&P 500 index for most investors. And then you should just keep buying the market every single month to benefit from dollar-cost averaging.

Image source: Getty Images.

Since all of the products that track the same index basically do the same thing, the Vanguard S&P 500 ETF is going to be a top choice. With an expense ratio of just 0.03%, it is one of the cheapest ways to gain exposure to the S&P. Why pay more for the same basic service? As the chart below shows, the market has recovered from even the worst bear markets and then moved on to reach even higher highs.

^SPX data by YCharts.

If you have $1,000 or $10,000 (or even more) to invest, just getting started is going to be the smartest move. Then, keep going and never look back.

Sure, in the near term, you might suffer through some paper losses. But over the long term, history suggests you’ll still make out just fine. If buying when things are expensive is just too much for you, however, you might find that the Vanguard Value ETF (VTV 0.51%) is an even smarter choice.

Why go the value route?

A $1,000 investment in the Vanguard Value ETF will buy you around five shares of the exchange-traded fund. What you will end up owning is a portfolio of large U.S. companies that have valuations that are low relative to the broader market. With the S&P 500 near all-time highs, that’s not an insignificant issue.

Putting some numbers on this might help. The Vanguard Growth ETF (VUG 0.56%), the opposite extreme from the value ETF, has an average price-to-earnings ratio of around 40. That’s pretty expensive, but you would expect that, given its focus on growth.

The Vanguard S&P 500 Index ETF has an average P/E of about 29. Still pretty high, thanks to the fact that some very large technology stocks (which tend to be growth-focused) are driving its performance. The Vanguard Value ETF’s average P/E is a little under 21. It wouldn’t be fair to call 21 cheap, but it is most certainly cheaper than both the S&P 500 and Vanguard Growth ETF.

The same trend exists with the price-to-book-value ratio (P/B). The Vanguard Growth ETF comes in with a P/B ratio of 12.5, the Vanguard S&P 500 Index ETF sits at 5.2, and the Vanguard Value ETF is the lowest on the valuation metric at just 2.8. While it won’t necessarily save you from a bear market, focusing on value stocks when growth is in favor could soften the pain of a deep downturn.

Get started first, but consider a value component when you do

To reiterate the theme here, the most important investment decision you can make is to start investing in the first place. The second one is to keep it up even when times get tough on Wall Street. But if you have already made those choices, then maybe it makes sense to consider taking a more nuanced approach with what you choose to buy.

If all you have is $1,000 to start, perhaps consider splitting it between the S&P 500 Index ETF and the Value ETF, to lean you toward cheaper stocks. If you already have a portfolio, then the smartest move could be to put a grand into just the Value ETF to help diversify you away from the growth stocks that are leading the market into the nosebleed seats.

Warren Buffett is well known for being perhaps the greatest stock picker of all time, and for good reasons. Berkshire Hathaway (BRK.A -0.88%) (BRK.B -1.03%), the conglomerate Buffett has led since the mid-1960s, has delivered unbelievable returns for investors over the years, and a big reason is Buffett’s success with using Berkshire’s capital to invest in stocks.

What makes Buffett’s investing style so extraordinary is how simple it is. Buffett invests in great businesses (mostly ‘boring’ ones) that he believes trade for significantly less than their intrinsic value and holds them for as long as they remain great businesses.

He doesn’t chase technology stocks or try to get in on the ground floor of the ‘next big thing.’ He doesn’t trade short-term. And he uses fairly basic investment principles, which he often shares with everyday investors. In addition to being the most successful investor, he is also the most quotable.

Image source: Getty Images.

Buffett’s advice to the average investor

Yes, Warren Buffett has an extraordinary track record when it comes to choosing individual stocks to invest in. But it’s also important to know that he spends many hours (usually over 10 per day) researching and reading.

Of course, you don’t need to spend that much time, but the point is that being a successful individual stock investor requires time and knowledge. As Buffett says, “If you like spending six to eight hours per week working on investments, do it. If you don’t, then dollar-cost average into index funds.”

To be perfectly clear, Buffett doesn’t think there’s anything wrong with this option. In fact, he has directed that his own wife’s inheritance be invested in this way after he’s gone.

Buffett has specifically mentioned the S&P 500 as a great way to bet on American business. And he says that “American business — and consequently a basket of stocks — is virtually certain to be worth far more in the years ahead.”

Buffett is a big fan of this S&P 500 ETF

There are several excellent S&P 500 index funds in the market, but one that Buffett has owned in Berkshire Hathaway‘s portfolio is the Vanguard S&P 500 ETF (VOO -1.28%). This fund simply tracks the 500 stocks in the index, in their respective weights, and should mimic the performance of the benchmark index over time.

Buffett is a big fan of Vanguard, which pioneered the low-cost index fund years ago. The Vanguard S&P 500 ETF has a rock-bottom 0.03% expense ratio, which means that you’ll pay just $0.30 in annual investment fees for every $1,000 in assets. To be clear, this isn’t a fee you physically have to pay — it will just be reflected in the fund’s performance over time. But it’s so low that it will barely have any impact on your long-term results.

You might be surprised at the potential

One final Buffett quote I’ll leave you with is “it isn’t necessary to do extraordinary things to get extraordinary results.” And it certainly applies to index fund investing.

Over the long run, the S&P 500 has produced annualized returns of about 10% over long periods of time. Let’s say that you invest just $200 per month in the Vanguard S&P 500 ETF and that you achieve 10% returns going forward.

• In 10 years, you’d have about $38,250.
• In 20 years, you’d have $137,460.
• In 30 years, you’d have nearly $395,000.
• In 40 years, you’d have about $1.06 million.

The key is to invest consistently and hold for a long time. The magic of long-term compounding will do the heavy lifting for you. As you can see, if you’re not comfortable with picking individual stocks, it doesn’t necessarily mean that you can’t use the stock market to build extraordinary wealth over time.