U.S. Markets closed

Warren Buffett: Target date funds aren't the way to go

Planning for retirement can be complicated and stressful. This is why target date funds — funds that are managed based on when you expect to retire — are so attractive. Over time, the balance of stocks, bonds and cash evolve automatically as retirement nears. Set it and forget it.

But is investing really that easy?

Yahoo Finance reader Greg Woodruff from Bakersfield, California asked Warren Buffett, the CEO Berkshire Hathaway (BRK-ABRK-B), if target date funds are really adding value.

“No, probably not,” Buffett said during a wide-ranging interview with Yahoo Finance’s Andy Serwer. “The S&P 500 Index Fund is the one to use. That’s the one I used in that bet I made for ten years. It’s the one I’ve told the trustee for my wife to put 90% of the funds I leave her in to.”

One of the pitfalls of target-date funds is the fees.

Buffett, who has argued that investors — both small and large — would be better off putting money in low-cost index funds, wrote in his 2005 shareholder letter that active management professionals (mutual funds, hedge funds, etc), as a group, would underperform the returns achieved “by rank amateurs who simply sat still.” His thought was that the active managers who collect massive fees would leave their clients “worse off” than the amateurs who simply invested in unmanaged low-cost index funds.

At that time, Buffett offered to wager $500,000 (for charity) that no investment professional could select a set of at least five hedge fund that would match the performance of an unmanaged S&P 500 index fund. The bet was to last ten years and Buffett picked a low-cost Vanguard S&P fund as his contender. Ten years later, Buffett sealed his victory with his S&P fund pick delivering an average annual return of 8.5% compared to the fund-of-funds’ 2.4% average annual gain.

Berkshire Hathaway CEO Warren Buffett waits to play table tennis during the Berkshire Hathaway annual meeting weekend in Omaha, Nebraska, U.S. May 7, 2017. REUTERS/Rick Wilking

According to Buffett, investing in the S&P 500 is like “buying America,” which he has long remained bullish on.

At age 11, during the first quarter of 1942, Buffett purchased three shares of Cities Service. The stock fell from $38.25 to $27. When the stock climbed back up to $45 per share Buffett sold his position. Eventually, the stock soared to $202 per share.

“If I put that $114 into the S&P 500 at that time and reinvested the dividends, I think of a figure as to what it might be would be worth today.”

Buffett estimates that it would be worth $400,000 today.

Of course, everyone’s ability to take risk will vary on a case by case basis. But Buffett’s message is clear: if you’ve got the time, go with the S&P 500.

Watch Warren Buffett LIVE at the 2018 Berkshire Hathaway Annual Shareholders Meeting exclusively on the Yahoo Finance app and desktop. Coverage begins May 5 at 9:45am ET. Set a reminder now!

Berkshire Hathaway’s annual meeting will be held on May 5.

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.