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 passing, the trustee of his wife’s inheritance was instructed to put 90% of her money into a very low-fee stock index fund and 10% into short-term government bonds.
While Berkshire Hathaway guru Warren Buffett said that he wanted his wife's inheritance to be invested 90% in stocks and 10% in bonds, he didn’t say that the 90/10 split makes sense for every investor.
Against the Norm
For investors regularly told to steer away from stocks as they age, this was pretty shocking stuff. A well-worn adage is to maintain a percentage of stocks equal to 100 minus one’s age – at least as a rule of thumb. So when you hit the age of, say, 70, most of your investment assets would be high-quality bonds that generally don’t take as big a hit during market downturns.
Because people are generally living longer and need to stretch their nest egg, some experts have suggested being a little more aggressive. Now, it’s more common to hear about 110 minus your age – or even 120 minus your age – as an appropriate portion of stocks. But 90% in equities, at any age? Even for someone with Buffett’s bona fides, that seems like a risky proposition.
100 Minus Your Age
The rule of thumb advisors have traditionally urged investors to use, in terms of the percentage of stocks an investor should have in their portfolio; this equation suggests, for example, that a 30-year old would be 70% in stocks, 30% in bonds, while a 60-year old would be 40% in stocks, 60% in bonds.
Will It Work for Every Investor?
Now, it’s important to point out that the Oracle of Omaha didn’t say 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.
And 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 in the investing community. But just how well would such a mix of stocks and bonds hold up in the real world?
- In a 2013 letter to Berkshire Hathaway shareholders, Warren Buffett noted an investment plan for his wife that seemed to contradict what many experts suggest for retirees.
- He wrote that after he passes, the trustee of her inheritance has been told to put 90% of her money into a stock index fund and 10% into short-term government bonds.
- Most often, investors are told to scale back on their percentage of stocks and increase their high-quality bonds as they age, so as to better protect them from potential market downturns.
- A Spanish finance professor put Buffett's plan to the test, looking at how a hypothetical portfolio set for 90/10 would have performed historically and found the results were very positive.
Putting 90/10 to the Test
One Spanish finance professor went to work finding the answer. In a published research paper, Javier Estrada of IESE Business School took a hypothetical $1,000 investment comprised 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 1900–1929 period and ending with 1985–2014, 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 some financial planners suggest retirees plan for. 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.
Figure 1. Estrada tested the failure rate of various asset mixes over 86 different historical periods. An asset allocation failed when the funds ran out before 30 years, assuming a fairly typical amount of withdrawals.
Source: Estrada, Javier. “Buffett's Asset Allocation Advice: Take it ... With a Twist.” October 26, 2015.
As one might expect, the potential gains for such a stock-heavy portfolio surpassed those of more conservative asset mixes. So not only did the 90/10 allocation do a good job of guarding against downside risk, but 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. But a portion of stocks any lower than that actually increases your risk, since bonds don’t typically generate enough interest to support retirees who reach an advanced age.
The Bottom Line
Recent research suggests that retirees might be able to lean heavily on stocks without putting their nest egg in grave danger. But if a 90% stock allocation gives you the jitters, pulling back a little might not be such a bad idea.