Warren Buffett doesn't think most people should try to pick individual stocks. He doesn't believe they need to do so. Instead, the Oracle of Omaha recommends that most investors put their money into a low-cost S&P 500 index fund. In his 2013 letter to Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) shareholders, he suggested going with a Vanguard fund.
That's good advice. The Vanguard 500 Index Fund ETF(NYSEMKT: VOO) tracks the S&P 500, has low expense fees, and has performed well over the long run. But I think that tweaking Buffett's recommendation a little could be an even better way to invest right now. Here's one no-brainer exchange-traded fund (ETF) to buy in October.
Think small, think cheap
It's hard to argue against Buffett's logic. To pick stocks that are likely to be winners over the long term requires a lot of analysis. Many people don't have the desire or time to do what it takes. Index funds, particularly ETFs, provide a great way to buy a large basket of stocks in one fell swoop. Buying low-cost funds also makes sense because high expenses can eat into your profits.
An S&P 500 ETF such as VOO is a great choice for long-term investors. Currently, though, the S&P 500 is valued at a premium. Because of this, there's a better way to employ Buffett's approach, in my view: Think small and think cheap with the Vanguard Small-Cap Value Index Fund ETF(NYSEMKT: VBR).
As its name indicates, VBR owns positions in small-cap value stocks. The index attempts to track the performance of the CRSP US Small-Cap Value Index. This index uses a ranking of all U.S. stocks to determine which stocks are small enough to include, rather than the traditional definition of small-cap stocks as those with market caps between $300 million and $2 billion. It then uses multiple valuation metrics to determine which stocks are attractively valued.
VBR currently owns 853 stocks with a median market cap of $5.6 billion and an average price-to-earnings ratio of 11.4 times. Its expense ratio is only 0.07%, much lower than the 1.14% average expense ratio of similar funds.
History is on its side
To be sure, VBR has badly underperformed VOO over the last 10 years as large-cap stocks delivered greater gains than small-cap stocks. However, history is on the side of small-cap value stocks over a longer period.
Multiple studies have been conducted through the years about which types of stocks perform the best over the long term. They've found that small-cap stocks outperform large-cap stocks. But small-cap value stocks deliver the best gains of all.
We're currently in an environment where interest rates and inflation are higher than they've been in recent years. Some experts believe that this dynamic won't just be temporary but will remain in place for a while. Doesn't that work to the advantage of larger companies instead of smaller ones? Not according to a report released by T. Rowe Price(NASDAQ: TROW) in 2022.
T. Rowe Price stated unequivocally: "U.S. small-cap companies have tended to outperform their larger counterparts during periods of heightened inflation and rising interest rates." The investment management company said that one potential reason for this is that many smaller businesses operate in niche industries and exert significant pricing power.
The big caveat
Investors should keep in mind the big caveat that every ETF and fund states in one way or another: Past performance isn't a guarantee of future results. Just because small-cap value stocks have delivered impressive gains over the long run doesn't necessarily mean that VBR will do so going forward.
However, Buffett has advised Berkshire shareholders that investors who diversify and keep their costs low are "virtually certain to get satisfactory results." VBR checks off both of his boxes. I predict that buying this ETF in October will pay off handsomely over the long term.
10 stocks we like better than Vanguard Index Funds-Vanguard Small-Cap Value ETF
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Keith Speights has positions in Berkshire Hathaway, Vanguard Index Funds-Vanguard Small-Cap Value ETF, and Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Berkshire Hathaway and Vanguard S&P 500 ETF. The Motley Fool recommends T. Rowe Price Group. The Motley Fool has a disclosure policy.
