DEFINITION of 90/10 Strategy
Legendary investor Warren Buffett invented the “90/10" investing strategy, which involves deploying 90% of one's investment capital in interest-bearing instruments that present a lower degree of risk, and allocating the remaining 10% of capital towards higher-risk investments. This is a relatively conservative investment strategy that aims to generate higher yields on the overall portfolio. Potential losses will typically be limited to the 10% that is invested in the high-risk investments, depending on the quality of bonds purchased.
BREAKING DOWN 90/10 Strategy
A common application of the 90/10 strategy involves the use of short-term Treasury Bills for the fixed-income component (90% of the portfolio), with the remaining 10% used for higher risk securities such as equity or index options or warrants. For example, an investor with a $100,000 portfolio who elects to employ a 90/10 strategy, might invest $90,000 in one-year Treasury Bills that yield 4% per annum, and would deploy the remaining $10,000, either towards equities listed in the S&P 500, or an index fund. If the S&P 500 returns 10% at the end of one year, the overall return on the portfolio would be 4.6% (0.90 x 4% + 0.10 x 10%). However, if the S&P 500 declines by 10%, the overall return on the portfolio after one year would be 2.6% (0.90 x 4% + 0.10 x -10%).
Of course, the “90/10” rule is merely a suggested benchmark, that may be easily modified to reflect a given investor’s risk tolerance. The higher the risk tolerance--the greater the equity portion of the equation will be. For instance, an investor who sits at the high end of the risk spectrum, might adopt a 70/30 or 60/40 model. The only requirement, is that the larger portion is earmarked for safer investments, like shorter term bonds that are A-rated or better.
Literally Putting His Money Where His Mouth Is
Buffet not only advocates for the “90/10” plan in theory, but he actively puts this principle into practice—notably as a trust and estate planning directive for his wife, as laid out in his will. As he once explained: “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. And 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. She’ll do fine with that. It’s low-cost, it’s in a bunch of wonderful businesses, and it takes care of itself.”