Worried about inflation? 1 investment strategy that Warren Buffett loves

In May 2021, Warren Buffett offered advice for investors to Berkshire Hathawaythe annual meeting of. For context, the stock market was skyrocketing at the time – the S&P 500 had climbed 48% in the previous 12 months – fueled by unbridled enthusiasm for stimulus checks, low interest rates and the reopening of businesses following the pandemic. But Buffett’s words were sobering.

He told his audience that many new investors were basically playing. Buffett also expressed his belief that index funds were a better option than individual stocks for the average person. Specifically, he recommended owning an index fund with a diversified group of US equities with a long-term horizon.

Of course, the macroeconomic environment is very different today. Soaring inflation and rising interest rates have caused the S&P500 at the crater, sending the benchmark into bearish territory. But inflation hit a new 40-year high in May, so things could get worse before they get better. The S&P 500 is currently 23% off its peak, but there have been six bear markets in the past 50 years, and the index has fallen more than 45% on three of those occasions.

Based on Buffett’s advice, here’s an investment strategy that could help your portfolio weather the current downturn.

A diversified index of dividend-paying stocks

Many dividend-paying stocks outperform the market during downturns, especially those that steadily increase their payouts. The reason is simple. Only high-quality companies generate enough cash to regularly pay shareholders a dividend that increases over time. If you reconcile this idea with Buffett’s advice, the Vanguard High Dividend Yield ETF (VYM -0.66%) sounds like an attractive investment idea right now.

The Vanguard High Dividend Yield ETF includes 443 U.S. stocks covering 10 market sectors, although 55% of the fund is allocated to consumer staples, energy, utilities, industrials and healthcare, which all tend to outperform in inflationary environments. Another 20% of the fund is invested in the financial sector, which tends to outperform in rising interest rate environments. To that end, the Vanguard High Dividend Yield ETF is currently only 14% off its peak, easily outpacing the 23% decline of the entire S&P 500.

It’s also worth noting that four of the index fund’s top 10 positions are stocks that Buffett owns through Berkshire Hathaway. Including Chevron and Bank of America, which represent 19% of Berkshire’s investment portfolio. Even better, the Vanguard High Dividend Yield ETF has an expense ratio of just 0.06%, meaning you’d only pay $6 on a $10,000 portfolio, and its dividend yield currently sits at 2. 72%, meaning a $10,000 portfolio would generate $272 in passive income each. year.

As a caveat, while the Vanguard High Dividend Yield ETF has significantly outperformed the broader S&P 500 over the past year, particularly when it comes to accounting for dividend payments, the S&P 500 generally wins long-term. For example, the S&P 500 has generated a total return of 65% over the past five years, while the Vanguard High Dividend Yield ETF has generated a total return of 47%.

However, you can’t put a price on peace of mind. If your current portfolio composition has you worried about the impact of runaway inflation, consider starting a position in this index fund. I think Warren Buffett would like the idea.

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