Warren Buffett’s 90/10 Portfolio: A Proven Strategy for Long-Term Wealth Building

Introduction

While All Weather, 60/40, and Permanent Portfolios offer balanced and diversified investment strategies, some investors may seek higher returns. The 60/40 portfolio, with its average return of 8.5% over the past 30 years, is a solid option but might not satisfy those looking for double-digit gains. Now, let's review Warren Buffett's 90/10 portfolio which historically posted a double-digit returns on average.

Portfolio Composition

Source: www.lazyportfolioetf.com

The 90/10 portfolio is championed by Warren Buffett. This approach involves allocating 90% of your assets to stocks (the S&P 500) and 10% to bonds (U.S. short-term treasuries). This aggressive allocation can potentially yield higher returns, but it also comes with increased risk.

For S&P 500 ETFs, popular choices include IVV, VOO, and SPLG. If you're unsure which one to select, refer to my previous post, "Finding the Best S&P 500 ETF: Comprehensive Comparison of Top Picks."

Historical Performance

Source: www.lazyportfolioetf.com

• Rebalancing on January 1st each year. Dividends are reinvested.
• Fees and capital gains taxes are assumed to be zero.
• Maximum period: January 1, 1871 – August 31, 2024

As of the end of September 2024, the 90/10 portfolio's year-to-date (YTD) return was 20.1%, and its 12-month return was 33.1%. These impressive figures are primarily due to the strong performance of the S&P 500.

However, when we extend the timeframe, the average annual returns become more modest. Over the past 10 years, the average annual return is 12.2%, and over the last 30 years, it drops to 10.1%. While still maintaining double-digit returns, it's important to note that the ultra long-term average (154 years) is 8.9%. This suggests that the stock market returns have been increasing in recent decades.

Maximum Drawdowns

Source: www.lazyportfolioetf.com

The 90/10 portfolio's historical performance has been marked by significant drawdowns, especially when compared to more conservative strategies like All Weather and Permanent Portfolios. Over the past 55 years (starting in 1970), the portfolio has experienced three drawdowns of 40% or more: in 1974, 2002, and 2009. There were also six instances of losses exceeding 20%.

In contrast, during the same period, the All Weather Portfolio experienced only one drawdown greater than 20% (-20.6% in 2022), and the Permanent Portfolio has never recorded a drawdown of that magnitude. The maximum drawdown for the Permanent Portfolio during this time was -15.9% in 2022.

Backgrounds

Creator: Warren Buffett. Buffett sends an annual letter to Berkshire Hathaway shareholders around the end of the first quarter each year. The contents of this letter are often covered well in the news. It has even been compiled into a book (which I recommend reading). In his 2013 annual letter, he revealed that he had arranged for his wife's inheritance to be managed by a trust with a simple asset allocation: 90% in low-cost S&P 500 index funds and 10% in short-term government bonds.

Logic: Warren Buffett stated that he believes the 90/10 portfolio will outperform most pension funds, institutions, and fund managers in the long run. Buffett's rationale is rooted in his unwavering belief in the long-term strength of the American economy. He believes that investing in a diversified basket of the largest and most successful U.S. companies (via an S&P 500 index fund) would likely outperform most professional investors over time.

Rebalancing: While Buffett himself hasn't explicitly discussed rebalancing, it's generally advisable to periodically adjust the portfolio's allocation to maintain the desired 90/10 ratio. Rebalancing every six months or even quarterly can help ensure that the portfolio stays aligned with the original investment thesis, especially given the potential for significant fluctuations in stock and bond prices.

Average Returns vs. Maximum Drawdowns

Returns: Compared to the All Weather, 60/40, and Permanent Portfolios, Warren Buffett's 90/10 portfolio has historically offered higher long-term average returns. 

Edited by Neo; as of Sep 30, 20024

While all four portfolios have performed exceptionally well in the recent past due to strong stock and bond markets, the 90/10 portfolio's higher equity allocation can lead to more significant fluctuations in returns. Therefore, it's essential to assess performance over longer timeframes, such as ten years or more, to get a more accurate picture of its risk-adjusted returns.

If you set your expectations based on the returns from the latest 12-months period, there’s a very high probability you’ll be disappointed later. When evaluating the 90/10 portfolio over a ten-year period, its average annual returns have slightly exceeded the 10% mark. This level of performance can be considered satisfactory for many investors seeking long-term growth.

Drawdowns: When assessing risk, I primarily focus on historical maximum drawdowns rather than statistical measures like standard deviation or Sharpe ratio. This approach allows me to visualize how I might emotionally cope with a significant market downturn and whether I could remain committed to my investment strategy.

The table below outlines the first and second maximum drawdowns for each of the four portfolios introduced (90/10, 60/40, All Weather, and Permanent Portfolio) over the past 55 years (1970-2024). As expected, the portfolios with higher historical returns have also experienced more substantial drawdowns.

Edited by Neo; as of Sep 30, 20024

The 90/10 portfolio, in particular, recorded a staggering -45.9% drawdown in 2009 during the global financial crisis. Indeed, there is no free lunch.  It highlights the inherent risk associated with its aggressive allocation to equities. Maintaining a disciplined approach during such market downturns requires a strong mindset and a clear understanding of your investment goals.

Closing Remarks

Traditionally, the investment community has favored a 60% stocks / 40% bonds asset allocation, often adjusted based on age (e.g., subtracting age from 100 to determine stock allocation). This means younger individuals are recommended to have a higher proportion of stocks, while older individuals are recommended to gradually increase their bond allocation. This is the basic approach of target date funds (TDFs).

The reason for having a higher stock allocation when younger is that with a longer investment horizon, one can enjoy the long-term high returns and compounding effects despite the stock market's high short-term volatility. While short-term stock losses can be challenging for any investor, younger individuals may have a greater capacity to weather them due to their future earning potential.

Those close to retirement or already retired may prefer stable income from investments, needing money for living costs, medical expenses, or maybe higher education expenses for children - this is why bonds are getting more suitable than stocks. Furthermore, when the stock market experiences a significant decline, it can take a long time to recover, which is disadvantageous when the investment horizon is short.

Buffett instructed that 90% of the stock allocation for the inheritance he would leave to his wife should be in stocks, which contradicts the common sense of asset allocation mentioned above. Buffett was born in 1930, while his wife was born in 1946. This means that regardless of when Buffett passes away, his wife will also be quite elderly.

Therefore, Buffett appears to reject the investment approach of reducing stock allocation as one ages. Of course, since the size of the inheritance will be substantial, it would be relatively easy to withstand significant volatility and losses. However, the more important point is that Buffett believed the 90/10 portfolio would outperform most asset management strategies, and he recommended this approach for his elderly wife as well.

Warren Buffett's 90/10 portfolio is rooted in a strong belief in the ongoing growth potential of the U.S. and the U.S. stock market. It is particularly suitable for those with a strong mindset who can endure the inevitable occasional significant losses from a long-term perspective. An average annual return of 10.1% may not seem impressive at first glance, but it means that an investment of 100,000 dollars would grow to 1.8 million dollars after 30 years. Most investors are likely to be satisfied with this result.

However, for those who do not feel confident in their ability to withstand occasional losses of 20-30%, it may be better to lower expected returns and choose a portfolio with higher defensive capabilities. Ultimately, the choice will depend on each investor's risk tolerance.

Thanks for reading. I wish you success in making smart investments!

This blog does not offer investment, financial, or advisory services. The information provided herein is for general informational purposes only and should not be interpreted as advice for making specific investment decisions. All investments involve risk, and past performance is not indicative of future results. It is advisable to consult with a qualified financial advisor to determine strategies or products that are appropriate for your individual circumstances. The owner, writer, or operator of this blog accepts no responsibility for any direct or indirect losses that may arise from the use of or reliance on the content presented. The information provided on this blog is subject to change and may not be current. The content is based on personal opinions, as well as information from news sources and research, and may vary due to shifts in personal opinions, financial market conditions, or other influencing factors. Most data referenced is derived from daily closing prices. Data finding, sorting, graphing, and analysis are performed primarily by myself, and while efforts are made to ensure accuracy, errors may be present. If you identify any inaccuracies, please inform me via comments or email, and I will endeavor to review and correct them as necessary. External content or images will be cited to the best of my ability.