The Glaring Reason Why Warren Buffett Isn't Buying His Favorite ETF Right Now

Globe and Mail

4 days ago

Key Points
Past clues point to the Vanguard S&P 500 ETF being Buffett's favorite exchange-traded fund.
The legendary investor isn't buying his favorite ETF because of a dangerously high valuation.
Buying the Vanguard S&P 500 ETF even at a high valuation could pay off over the long term, but only if you buy and hold.
10 stocks we like better than Vanguard S&P 500 ETF ›
Warren Buffett loves investing in stocks. However, he doesn't encourage all investors to follow in his footsteps. Instead, the Oracle of Omaha believes that the best approach for most people is to invest in funds rather than individual stocks.
His premise is that it takes a lot of research to understand businesses well enough to put your money at risk investing in them. Exchange-traded funds (ETFs) own lots of stocks, so extensive research isn't required. And they can be bought and sold just like stocks.
While there are thousands of ETFs on the market, Buffett especially likes one. But there's a glaring reason why even Buffett isn't buying his favorite ETF right now.
Buffett's favorite ETF
What is Buffett's favorite ETF? He has provided three big clues in the past.
Clue No. 1 came in Buffett's 2013 letter to Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) shareholders. He wrote: "The goal of the non-professional should not be to pick winners -- neither he nor his 'helpers' can do that -- but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal."
Buffett's second clue was in the same shareholder letter. And it was even more direct. He noted that his will specifies that 90% of the cash his family inherits when he dies be invested "in a very low-cost S&P 500 index fund." He then added, "I suggest Vanguard's."
Now for the third clue. Buffett has owned only two ETFs in recent years in Berkshire's portfolio. One was the SPDR S&P 500 ETF Trust (NYSEMKT: SPY). The other was the Vanguard S&P 500 ETF (NYSEMKT: VOO), which has a slightly lower annual expense ratio than the SPDR ETF.
Guess which one of these two S&P 500 (SNPINDEX: ^GSPC) index funds had more of Berkshire's cash invested in it? Pat yourself on the back if your answer was the Vanguard ETF. I think these clues clearly point to the Vanguard S&P 500 ETF as Buffett's favorite ETF.
Why he isn't buying it
However, Berkshire completely exited its position in the Vanguard S&P 500 ETF in the fourth quarter of 2024. (It sold all of its shares of the SPDR S&P 500 ETF Trust during the quarter as well.) Furthermore, the legendary investor has not bought a single share of his favorite ETF since.
I don't think Buffett has changed his mind about the wisdom of investing in S&P 500 index funds. I don't believe he no longer views the Vanguard S&P 500 ETF as a good long-term pick for investors, either. So why isn't Buffett buying his favorite ETF? I think the glaring reason is...valuation.
One metric that highlights the concerning valuation of the Vanguard S&P 500 ETF and the overall stock market is named after Buffett himself. The Buffett indicator measures the total market capitalization of all U.S. stocks as a percentage of U.S. GDP.
Buffett stated in an article published by Fortune magazine in 2001 that when this indicator approaches 200%, investors are "playing with fire." Today, the Buffett indicator stands at nearly 209%. Granted, this metric uses the Wilshire 5000 index, which includes all U.S. stocks. However, the S&P 500 makes up around 80% of the total market capitalization of U.S. stocks.
Should you buy this ETF even though Buffett isn't?
Buffett's warning about "playing with fire" rings in my ears. So does his advice in the 2013 Berkshire Hathaway shareholder letter to "invest in stocks as you would in a farm." I probably wouldn't buy a farm when land prices were at all-time highs, especially if I suspected they would be cheaper in the not-too-distant future.
That said, I don't think investors would make a huge mistake by buying the Vanguard S&P 500 ETF right now, even though Buffett isn't -- if they hold the ETF for the long term. I'd be surprised if the S&P 500 (and ETFs that track the index) aren't valued more highly 20 years from now than they are today.
Buffett pointed out a risk to keep in mind, though. He wrote in the 2013 letter, "The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur." If you think you'll succumb to the temptation to sell if the Vanguard S&P 500 ETF declines sharply, don't buy it.
However, Buffett also provided an "antidote" to this potential problem. He suggested accumulating shares over time and never selling on bad news or major pullbacks. If you follow these rules, Buffett argued, you're "virtually certain to get satisfactory results."
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