Legendary investor Warren Buffett introduced the “90/10” strategy in his 2013 letter to Berkshire Hathaway shareholders. This innovative strategy suggests allocating 90% of your investment capital into low-cost stock index funds and the remaining 10% into low-risk government bonds.
Unlike traditional strategies that lean towards a higher percentage of bonds as the investor ages, the 90/10 strategy maintains a more aggressive stance.
Key Takeaways
- The 90/10 strategy recommends investing 90% of your capital in low-cost S&P 500 index funds and 10% in short-term government bonds.
- This unique methodology was highlighted by Warren Buffett in his 2013 shareholder letter.
- A 90/10 investment strategy is aggressive, making it suitable for individuals with high risk tolerance and not ideal for everyone.
How Does the 90/10 Strategy Work?
For decades, Buffett’s annual letters to shareholders have been highly anticipated. His 2013 letter introduced many to the 90/10 strategy. Buffett stated:
My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit…. 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.) 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.
A Real-world Application of the 90/10 Strategy
Consider an investor with a $100,000 portfolio employing the 90/10 strategy. They could invest $90,000 in an S&P 500 index mutual fund or ETF, while allocating $10,000 to Treasury bills (T-bills).
T-bills are short-term government-issued debt with maturities of up to one year. These can be directly purchased from the government, through brokers, or via mutual funds or ETFs. Known for their safety, T-bills are considered one of the lowest-risk investments.
To calculate the performance of a 90/10 portfolio, multiply each portion by its annual return. For example, with a 10% return from the S&P 500 and 4% from T-bills, the calculation (0.90 x 10% + 0.10 x 4%) yields a 9.4% overall return.
Minimizing Fees
Buffett emphasizes investing in index funds due to their minimal fees, as they’re passively managed. Rather than employing managers to make stock selections, these funds replicate stock indices like the S&P 500, which is based on 500 significant U.S. corporations.
Many studies indicate that few managers consistently outperform indices. Therefore, choosing low-cost index funds is crucial, making sure to compare both performance and expense ratios. All else being equal, select the fund with the lower expense ratio.
Avoid funds with sales commissions or ’loads’ which reduce the investment’s capital. No-load funds are preferable and can be purchased directly from fund companies or through discount brokers.
Criticisms of the 90/10 Strategy
The 90/10 allocation is often criticized for its high risk and potential volatility. Comparatively, other strategies recommend a higher bond percentage as investors age. For instance, subtracting your age from 110 offers a more conservative stock percentage.
The high concentration in stocks makes the 90/10 portfolio vulnerable to market fluctuations, which com critics caution can be emotionally challenging for risk-averse investors or those with shorter investment horizons.
Advantages of a 90/10 Investment Allocation
This strategy’s primary advantage lies in the potential for higher long-term returns due to substantial stock exposure. It’s suitable for investors with high risk tolerance and long-term goals, such as saving for retirement far in the future.
Is the 90/10 Allocation Suitable for Conservative Investors?
Generally, this aggressive strategy may be deemed unsuitable for conservative investors who prioritize capital preservation over growth. For such investors, the associated volatility and risk are often deterrents.
How Often Should You Rebalance a 90/10 Portfolio?
Periodic rebalancing, typically annually or when holdings deviate significantly from the target, is essential. Adjust your stock/bond mix to maintain the desired 90/10 allocation. Consider rebalancing when your stock allocation drifts above 95% or below 85%, regardless of time passage.
The Bottom Line
A 90/10 investment allocation is for the investor with a high risk threshold and a long time horizon. While Warren Buffett’s success makes this strategy attention-worthy, it may not be appropriate for everyone.
Related Terms: passive investing, index funds, asset allocation, risk tolerance, long-term investment.
References
- Berkshire Hathaway Inc. “2013 Annual Report”, Page 20.
- TreasuryDirect.gov. “Treasury Bills”.
- S&P Dow Jones Indices. “SPIVA U.S. Scorecard”.
- CNNMoney. “Should I Follow Warren Buffett’s 90/10 Investing Strategy?”
