Warren Buffett Says to Buy This Kind of ETF. One Could Turn $1,000 Per Month Into $252,000 in 10 Years.

Key Points

• Warren Buffett is a phenomenal stock picker, but he recommends most people adopt a passive approach.

• Investors who use a dollar-cost averaging strategy could reap huge financial gains over the long term.

• The S&P 500's valuation is high, but that shouldn’t stop investors from putting money to work.

• 10 stocks we like better than Vanguard S&P 500 ETF ›

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Warren Buffett is viewed as one of the greatest investors ever. That's because his expertise at capital allocation while running Berkshire Hathaway has resulted in a tremendous track record. The conglomerate has returned nearly 20% annualized for about six decades.

While the average investor wants to emulate the Oracle of Omaha's success, even Buffett says that the best course of action for most people is to take a totally different approach. At Berkshire's 2021 annual meeting, he said that buying an S&P 500 index fund is a smart way to benefit from the stock market's growth over time. And even small sums of money can balloon into a massive amount with patience and discipline.

Following Buffett's advice, investors should consider buying one Vanguard exchange-traded fund (ETF) that could turn $1,000 per month into $252,000 in 10 years.

Image source: Getty Images.

Dollar-cost averaging mixed with compounding

The stock market has had a wonderful run in recent memory. In the past decade, the S&P 500 index has produced a total return of 255%, a figure that assumes dividends were reinvested. That translates to an annualized return of 13.5%, well ahead of the index's long-term average of a 10% yearly gain.

Investors can buy the Vanguard S&P 500 ETF (NYSEMKT: VOO) to play this trend. It tracks the performance of the stocks in the S&P 500 and it's offered by a very reputable firm that not only has trillions in assets under management, but that's been around for five decades. That should give investors some peace of mind.

While the past never guarantees what will happen in the future, if the next 10 years looks like the last 10, investors who allocate $1,000 on a monthly basis to the Vanguard S&P 500 ETF over the next 10 years ($120,000 total) would see their balance reach a whopping $252,000 in the summer of 2035. This is a dollar-cost averaging approach, which requires investors to invest a certain amount at a consistent interval no matter what the market is doing at that particular time. It allows investors to take advantage of different entry valuations.

The Vanguard S&P 500 ETF has an expense ratio of only 0.03%. I'm sure this is another factor that Buffett appreciates, as he has a disdain for high-priced money managers that tend to underperform the market.

What the future might hold

No investor would complain about the Vanguard S&P 500 ETF's total return in the next 10 years matching the 255% it generated in the previous decade. But nothing is guaranteed. And performance could be worse or better. There are factors that play to both sides.

The return could be worse mainly because right now the S&P 500 carries a historically expensive valuation. The CAPE ratio (cyclically adjusted price-to-earnings ratio) currently sits at 37.8. Past data shows that returns going forward are low when the starting multiple is high, as it is today.

Moreover, a period of higher interest rates or other macro headwinds could cause investors to be more averse to risk, leading to lower demand for equities. I wouldn't be surprised to see a reversion back to the historical 10% yearly returns. This makes the most sense.

However, returns could match the past decade's gains or even be higher as well. One reason is that government spending and debt are going to keep rising, flooding the system with liquidity that can push up asset prices. This is what we've seen since the global financial crisis of 2007-2009.

Maybe the right outlook to have is somewhere in the middle. But remember that no one can predict what the S&P 500 index will do between now and 2035. What matters is that investors make the decision to start investing in the Vanguard S&P 500 ETF early and often and they will be able to match that broad index's performance, minus fees.

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Neil Patel has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Berkshire Hathaway and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.