Is Warren Buffett’s 90/10 Asset Allocation Sound? (2024)

When most people challenge deeply ingrained wisdom about finances, they’re greeted with eye rolls. When one of the world’s most successful financial gurus is the contrarian, people listen.

Such was the case with Warren Buffett’s 2013 letter to Berkshire Hathaway investors, which seemed to challenge one of the longstanding axioms about retirement planning. Buffett noted that upon his death, the trustee of his wife’s inheritance was instructed to put 90% of her money into a very low-fee stock index fundand 10% into short-term government bonds. This is what is called the “90/10 investing strategy.”

Against the Norm

A well-worn adage in financial investing is to maintain a percentage of stocks equal to 100 minus one’s age, at least as a rule of thumb. For example, when you hit the age of, say, 70, you'll likely want most of your investment assets to be high-quality bonds that generally don’t take as big a hit during market downturns. Therefore, at age 70, 70% of your portfolio would be low-risk fixed-income securities while the remaining 30% would be higher-risk equities.

Because people are generally living longer and need to stretch their nest eggs, some experts have suggested being a little more aggressive. It’s now more common to hear about 110 minus your age, or even 120 minus your age, as an appropriate portion of stocks. Still, 90% in equities, at any age? Even for someone with Buffett’s bona fides, that seems like a risky proposition.

Will It Work for Every Investor?

It’s important to point out that the Oracle of Omaha didn’tsay that the 90/10 split makes sense for every investor. The larger point he was trying to make was about the makeup of portfolios, not the precise allocation. His main contention was that most investors will get better returns through low-cost, low-turnover index funds, an interesting admission for someone who’s made a fortune picking individual stocks.

There’s an obvious distinction between Mrs. Buffett and most investors. While we don’t know the exact amount of her bequest, one can assume she’ll get a cushy nest egg. She can likely afford to take on a little more risk and still live comfortably. Still, this 90/10 allocation drew considerable attention from the investing community. Just how well would such a mix of stocks and bonds hold up in the real world?

Understanding Low-Fee Index Funds

A crucial part of Buffet's 90/10 plan is the low-fee index fund. Low-fee stock index funds offer numerous advantages to investors. First, their cost-efficiency ensures that a significant portion of invested capital actively contributes to returns, reducing long-term erosion and fostering portfolio growth. Additionally, these funds provide instant diversification across various companies and sectors, spreading risk and mitigating the impact of underperforming individual stocks.

Index funds usually aim for consistent performance by tracking their underlying indices closely, delivering predictable returns over time. These funds' passive management, low turnover, and tax efficiency lead to lower expenses and taxes compared to actively managed counterparts, making them an attractive option for long-term investors seeking to save money on fees.

Despite these advantages, it's crucial to acknowledge that index funds are not without market risks. Holding 90% of one's portfolio in equities can only diversify one to a certain degree. In fact, weighted indexes may slant heavier towards larger companies, concentrating holdings. Without active management, passive funds simply strive to match index returns, potentially leaving returns on the table.

Putting 90/10 to the Test

One Spanish finance professor went to work to find the answer. In a published research paper, Javier Estrada ofIESEBusiness School took a hypothetical $1,000 investment composed of 90% stocks and 10% short-term Treasuries. Using historical returns he tracked how the $1,000 would do over a series of overlapping 30-year time intervals. Beginning with the 1900 to 1929 period and ending with 1985 to 2014, he collected data on 86 intervals in all.

To maintain a more-or-less constant 90/10 split, the funds were rebalanced once a year. In addition, he assumed an initial 4% withdrawal each year, which was increased over time to account for inflation.

One of the key metrics Estrada looked for was the failure rate, defined as the percentage of time periods in which the money ran out before 30 years, the length of time for which some financial planners suggest retirees plan. As it turned out, Buffett’s aggressive asset mix was surprisingly resilient, failing in only 2.3% of the intervals tested.

What’s equally surprising is how this portfolio of 90% stocks fared during the five worst time periods since 1900. Estrada found that the nest egg was only slightly more depleted than a much more risk-averse 60% stock and 40% bond allocation.

As one might expect, the potential gains for such a stock-heavy portfolio surpassed those of more conservative asset mixes. Not only did the 90/10 allocation do a good job of guarding against downside risk; it also resulted in strong returns.

According to Estrada’s research, the safest asset mix was actually 60% stocks and 40% bonds, which had a remarkable 0% failure rate. Notably, a portion of stocks any lower than that actually increases your risk, as bonds don’t typically generate enough interest to support retirees who reach an advanced age.

Disregarding Alternative Assets

Another investment option that is disregarding in this plan are alternative investments. Alternative investments offer several benefits to investors seeking to diversify their portfolios beyond traditional asset classes like stocks and bonds. These assets often have low correlation with traditional investments, meaning they may perform differently during various market conditions. Alternative investments may also offer the potential for higher returns. Additionally, some alternative investments can serve as a hedge against inflation since they often have intrinsic value tied to real assets like real estate, commodities, or infrastructure.

It's important to note that Buffet's 90/10 rule is rooted in simplicity. The expectation is that an investor can be appropriately diversified between the two main asset classes and do not need to take on potential additional risk to invest in alternatives. For investors who are interested in these less traditional asset classes, the 90/10 rule may not be suitable.

The Bottom Line

Recent research suggests that retirees might be able to lean heavily on stocks without putting their nest eggs in grave danger. However, if a 90% stock allocation gives you the jitters, pulling back a little is a perfectly acceptable choice.