Warren Buffett is one of the greatest investors ever, so when he offers insight into his investment strategy, people tend to listen. Buffett has made his fortune identifying undervalued businesses and buying them for the company he has led for 60 years, Berkshire Hathaway.
Berkshire shareholders have been rewarded enormously during Buffett’s stewardship, with the stock returning 19.9 percent annually since 1965, compared to 10.4 percent for the S&P 500.
So it may have come as a surprise when Buffett revealed that his wife’s inheritance would be held in a trust, with 90 percent of the money in an S&P 500 index fund and the remaining 10 percent in short-term government bonds.
If you’re trying to decide what portfolio allocations make the most sense for you, it may be helpful to meet with a financial advisor. Bankrate’s financial advisor matching tool can help you find an advisor in your area.
Here’s what Buffett had to say about the 90/10 approach and whether the strategy makes sense today.
In his 2013 letter to Berkshire shareholders, Buffett touted the benefits of investing in stocks over the long term and explained how even someone who knows very little about investing can achieve satisfactory results. He highlighted the point by explaining his instructions for how his wife’s inheritance should be invested once he’s no longer around.
“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.),” Buffett wrote. “I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
Buffett elaborated on his advice in an interview with CNBC after the letter was released.
“I laid out what I thought the average person who is not an expert on stocks should do. And my widow will not be an expert on stocks,” Buffett said. “I want to be sure she gets a decent result. She isn’t going to get a sensational result, you know?”
“The reason for the 10% in short-term governments is that if there’s a terrible period in the market, and she’s withdrawing 3% or 4% a year, you take it out of that instead of selling stocks at the wrong time,” Buffett said. “She’ll do fine with that. And anybody will do fine with that. It’s low-cost, it’s in a bunch of wonderful businesses, and it takes care of itself.”
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Buffett’s 90/10 portfolio has a lot of appeal, but it likely doesn’t make sense for every investor. Buffett’s widow is likely to inherit substantially more than she needs to live on (all his Berkshire shares are going to charity), so even extreme stock market volatility isn’t likely to impact her way of life.
But volatility isn’t something every investor is comfortable with, says Ryan Linenger, a Chicago-based financial advisor with Plante Moran.
“It can be very difficult for many investors to stomach the amount of volatility in a 90% equity portfolio,” Linenger said. “It can be detrimental for an investor to be invested in a portfolio that they can’t stick with when markets get tough – often this leads to really poor decision making and can drastically reduce the returns an investor should be receiving over time.”
Using an S&P 500 index fund for a substantial portion of the “growth side” of a long-term portfolio may make sense, Linenger said, but he thinks investors can still benefit from broader diversification.
The 90/10 portfolio “would exclude most of the publicly traded companies in the U.S. and globally, in addition to other segments of the bond market – unnecessarily reducing the investment opportunity set,” Linenger said.
Simplicity: The 90/10 approach is simple to follow and makes portfolio rebalancing easy to manage.
Low-cost: Index funds that track the S&P 500 are very low cost, typically costing about $3 for every $10,000 you have invested and there are even some with no expense ratio.
Stock market growth: By having 90 percent of the portfolio in an S&P 500 index fund, you’ll benefit from the long-term performance of stocks, which has been around 10 percent annually over long time periods.
Diversification: By choosing a broadly diversified index fund, investors don’t have the risk that comes with trying to pick specific winners and losers.
High allocation to stocks: The main disadvantage of the 90/10 portfolio is that the vast majority of your money is exposed to the volatility of stocks.
Risk for retirees: Some retirees may not be comfortable with such a high allocation to stocks. A lower-risk portfolio with a higher allocation to fixed income investments may be a better fit for some.
Not a good fit for investors with a low risk tolerance: Some investors aren’t able to handle stock market volatility and may make poor decisions at the worst times (namely, when stocks have declined).
Buffett’s 90/10 portfolio can be a simple and low-cost way to manage a portfolio that can withstand considerable volatility. But investors that are more sensitive to stock market fluctuations should consider holding fewer stocks and broadly diversifying, in an effort to ensure they can stick to their plan and achieve their long-term financial goals. You may also want to consult with a financial advisor for further guidance.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
