Warren Buffett compares active trading to one night stand: Here's how he suggests you invest

Low-cost index funds

One reason why Buffett likes index funds is their relatively low cost compared to actively managed funds.

In a letter³ he wrote to Berkshire Hathaway AGG investors, in 2016, he states: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Despite recent pivotal changes — a global pandemic, several wars, extreme weather events, ongoing economic strife along with rapid use of innovation around technology, in particular artificial intelligence — Buffett remains steadfast in his recommendations to investors: Keep fees low and avoid the temptation to try and beat the market. As he often states, investors need to think twice about where they put their money and not dwell on dramatic headlines.

Reflecting on his first ever stock purchase — when he paid USD$114.75 to buy three shares of Cities Service preferred stock at age 11 in 1942 — he once told CNBC’s Becky Quick: “The best single thing you could have done on March 11, 1942 when I bought my first stock was just buy an index fund and never look at a headline, never think about stocks anymore.”⁴

He added if, in 1942, he'd "put USD$10,000 in an index fund and reinvested dividends … it would come to USD$51 million now."

Investors keen to follow his advice, should consider creating a portfolio that keeps fees and costs low and avoids the need to time the market. To accomplish this, most investors will want to consider low-cost exchange-traded funds (ETFs), which trade like stock, but offer investors shares in a basket of equity holdings — allowing an investor the liquidity of stock trading, the diversification that comes with pooled funds but at a very competitive and efficient cost.

To help, here are five low-cost index funds along with five ETFs funds that Canadian investors can find on the Toronto Stock Exchange (TSX).

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5 low-cost index funds for Canadian investors

• iShares S&P/TSX Capped Composite Index ETF (TSX:XIC): This ETF tracks the performance of the S&P/TSX Capped Composite Index, providing exposure to a broad range of Canadian stocks.
• Vanguard FTSE Canada All Cap Index ETF (TSX:VCN): This ETF seeks to track the performance of the FTSE Canada All Cap Index, which includes Canadian large, mid, small, and micro-cap stocks.
• BMO S&P/TSX Capped Composite Index ETF (TSX:ZCN): This ETF aims to replicate the performance of the S&P/TSX Capped Composite Index, offering diversified exposure to Canadian equities.
• Horizons S&P/TSX 60 Index ETF (TSX:HXT): This ETF tracks the S&P/TSX 60 Index, which consists of 60 of the largest and most liquid stocks listed on the TSX.
• iShares Core S&P/TSX Capped Composite Index ETF (TSX:XIC): Similar to the first one listed, this ETF also tracks the performance of the S&P/TSX Capped Composite Index, providing exposure to a broad range of Canadian stocks.

These index funds are low-cost, passively managed, and offer diversification across various segments of the Canadian stock market. To buy and trade these low-cost funds, investors will first need to an account with an online brokerage or trading app.

5 low-cost index funds for Canadian investors

• iShares Core Balanced ETF Portfolio (TSX:XBAL): This ETF is designed to provide a balanced exposure to a mix of equity and fixed income securities, offering diversification across Canadian, US, and international markets, as well as bonds.
• Vanguard Balanced ETF Portfolio (TSX:VBAL): This ETF aims to provide a balanced portfolio by investing in a mix of equity and fixed income securities, including Canadian, US, and international stocks, as well as bonds.
• BMO Balanced ETF Portfolio (TSX:ZBAL): This ETF seeks to provide a balanced investment solution by investing in a diversified mix of Canadian, US, and international equities, along with fixed income securities.
• Horizons Balanced TRI ETF Portfolio (TSX:HBAL): This ETF offers a balanced exposure by investing in a mix of equity and fixed income securities, including Canadian, US, and international stocks, as well as bonds.
• RBC Global Asset Management Balanced ETF (TSX:RBAL): This ETF aims to provide a balanced portfolio by investing in a diversified mix of Canadian, US, and international equities, as well as fixed income securities.

These ETFs offer a convenient way for Canadian investors to access a diversified portfolio with exposure to both equity and fixed income securities, all while keeping costs low. Like stocks, investors will need an online trading account. Good options include:

• CIBC Investor’s Edge: Get up to $100 in commission-free options until October 31, 2024
• Wealthsimple Trading: Get $25 and commission free trades when you open and transfer $150 or more into the trading account
• Questrade: Get a $50 trade commission rebate

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For investors interested in building an investment portfolio without the constant need to track, research and trade, check out Wealthsimple’s auto-invest account. Right now, new customers can open an account, deposit $500 or more and get $25 in cashback rewards.

Another great option is Moka. For a flat-fee, investors can invest in stocks, ETFs and mutual funds while taking advantage of the app's round-up feature — extra cents are collected and used for additional investment opportunities — as well as access to managed portfolios. While the firm has been around for quite some time, it only recently launched the flat-fee robo-advisor suite of five portfolios to Canadian investors with the promise that your spare change can be proactively used to grow your savings.

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2 low-cost index funds recommended by Warren Buffett

Vanguard S&P 500 ETF (NYSE:VOO): Buffett is a fan of the Vanguard S&P 500 ETF (VOO). In fact, he singled it out as his low-cost S&P 500 index fund of choice in his 2013 letter to shareholders. VOO tracks the top 500 U.S.-based companies on the stock exchange and is generally considered to be a barometer of the health of the economy. It gives investors exposure to the earnings of high-performing companies — including some of Buffett’s favourite stocks, like Apple, Bank of America Corp and Coca-Cola — without having to bet on each stock individually.

Since VOO’s inception in September 2010, as of November 30, the fund has achieved an average annual return of 13.58%, just shy of the benchmark S&P 500 index, which returned 13.62% over the same period. Another attractive element of VOO is its very low expense ratio of only 0.03%, much lower than the average expense ratio of similar funds, which is more like 0.79%.

Vanguard Real Estate ETF (NYSE:VNQ): If you’re not swayed by the stock market and are more interested in alternative assets, you may want to consider the Vanguard Real Estate ETF (VNQ). VNQ tracks the performance of publicly traded real estate investment trusts (REITs) and other real-estate-related investments. It gives investors exposure to income-producing commercial real estate like apartment buildings, offices and industrial complexes. While Buffett has shown little desire to buy and manage real estate, he has invested in several REITs over the years. These publicly traded property portfolios distribute at least 90% of its taxable income to shareholders in the form of dividends — and if you reinvest those dividends, you can achieve great compound growth over time.

Since VNQ’s inception in 2004, as of November 30, it has achieved an average annual return of 7.18%, just shy of its benchmark index, which achieved 7.21%. The fund has another relatively low expense ratio of 0.12%.

2 options for Canadian investors looking to avoid foreign withholding tax

While both funds are great Canadian investors need to be mindful of withholding tax and currency exchange fees — two costs associated with non-Canadian investments that can seriously erode earnings if not managed properly. If you're still interested in the underlying investment strategy, but don't want to bother with timing currency exchanges or the hassle of Internal Revenue Service (IRS) withholding tax disclosures, there are alternatives traded on the TSX.

Instead of the VOO, opt for the Vanguard S&P 500 ETF (TSX:VFV) with a management expense ratio (MER) of 0.09%. Instead of the VNQ, investors can select the iShares Global Real Estate Index ETF (TSX: CGR) with an MER of 0.72%.

For investors who want to replicate Warren Buffett's success, choose this 1 equity investment

Berkshire Hathaway (NYSE:BRK.B): Buffett recommends low-cost index funds for average traders, but that’s not how he made his fortune. Rather, he invested in individual stocks. If you want to follow in the billionaire’s footsteps, investing in his conglomerate Berkshire Hathaway (NYSE:BKR.B) is one way to get started. Berkshire Hathaway is a holding company that owns a diverse range of private businesses in sectors like insurance, utilities and energy, freight rail transportation, finance, manufacturing, retail and services. It’s so diverse, it’s like a mini index fund in and of itself. Berkshire Hathaway offers Class A stock (BRK.A) and Class B stock (BRK.B). BRK.A is the company’s original stock option and comes with a stratospheric price tag, most suitable for accredited and institutional investors. Meanwhile, BRK.B, first issued in 1996, is more modestly priced and affordable to smaller investors.

In the past decade, BRK.B stocks have shot up in value by around 204%. As of December 29, 2023, the stock is up nearly 16%. In the third-quarter of 2023, the conglomerate reported earnings per share of USD$4.96, beating its original estimate of USD$4.36.

In his 2023 Thanksgiving letter⁵ to shareholders, Buffett described Berkshire Hathaway as “one of the largest and most diversified companies in the world.” He lauded the company’s longevity: “Decay can occur at all types of large institutions, whether governmental, philanthropic or profit-seeking. But it is not inevitable. Berkshire’s advantage is that it has been built to last.”

Bottom line

Warren Buffett advocates for low-cost passive index funds or ETFs as the primary investment tool for the average investor due to their simplicity, diversification, and cost-effectiveness. These investment vehicles allow investors to gain exposure to a broad range of assets, such as stocks or bonds, without the need for active management or high fees. Buffett believes that over the long term, low-cost index funds tend to outperform actively managed funds after accounting for fees and expenses, making them a reliable and efficient way for investors to participate in the growth of the overall market.

Sources

1 Berkshire Hathaway: Letter to shareholders (1991)

2 Berkshire Hathaway: Letter to shareholders (2013)

3 Berkshire Hathaway: Letter to shareholders (2016)

4 CNBC: Becky Quick's interview with Warren Buffett (2021)

5 Berkshire Hathaway: Letter to shareholders (2023)

— with files from Bethan Moorcraft