The Warren Buffett 90/10 ETF Portfolio

Warren Buffett hardly needs an introduction, but just in case you’re new to the investing world, here’s a quick primer.

Buffett is a legendary value investor and the chairman of Berkshire Hathaway (BRK.A, BRK.B), which he transformed from a struggling textile mill into a fortress-like conglomerate, delivering market-beating returns for decades.

Interestingly, while Buffett is renowned for his stock-picking prowess, he also left some sage advice for the average investor in his 2023 shareholder letter. Regarding the plans for his estate after he passes, Buffett gave surprisingly simple guidance:

“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'm always wary of authority bias, but on the surface, this seems like a pretty sound strategy for many folks. In this guide, I’ll break down my analysis of why this might work and which ETFs you could use if you want to implement Buffett’s straightforward investing approach.

Why the S&P 500?

Warren Buffett's endorsement of the S&P 500 isn't arbitrary. He's a staunch believer in U.S. stocks, and the S&P 500 is a widely followed, longstanding benchmark that reflects the performance of the U.S. large-cap market.

Moreover, the S&P 500 is no slouch when it comes to performance. According to the latest SPIVA update, about 88% of all U.S. large-cap funds have underperformed the S&P 500 over a 15-year period. This underperformance is largely attributed to higher fees and turnover rates.

You have a ton of options for S&P 500 exposure. While Buffett has shown a preference for Vanguard products, there’s actually an even cheaper option available from State Street—the SPDR Portfolio S&P 500 ETF (SPLG), which carries a minuscule 0.02% MER. That translates to just about $2 in fees per $10,000 invested.

Sure, one could critique this strategy for its lack of mid-caps, small-caps, and international exposure. However, in this case, we're banking on the ultra-low fees and minimal turnover to drive decent returns, with maximum diversification taking a back seat.

Why short-term Treasurys?

The allocation of 10% to short-term Treasurys in Warren Buffett's investment strategy might seem peculiar to some, but for those familiar with his views, it’s quite fitting.

In a 1979 shareholder letter, Buffett expressed his skepticism about long-term, fixed-interest bonds denominated in dollars, especially in an environment where the value of the dollar seemed likely to decrease over time. He wrote:

"We have severe doubts as to whether a very long-term fixed-interest bond, denominated in dollars, remains an appropriate business contract in a world where the value of dollars seems almost certain to shrink by the day. Those dollars, as well as paper creations of other governments, simply may have too many structural weaknesses to appropriately serve as a unit of long-term commercial reference."

Buffett's concerns were vindicated in 2022 when long bonds with high durations suffered significant losses due to rising interest rates, with drawdowns even deeper than those experienced by stocks. While I believe long-term bonds still have their uses, they may not be the most suitable asset class for novice investors due to their sensitivity to interest rate changes.

Buffett’s preference leans towards short-term bonds, specifically Treasury bonds. His rationale for keeping 10% in short-term Treasurys is to have a "safe reserve"—a dry powder to acquire assets at lower prices through rebalancing, or to provide financial security for his wife after his passing. Given his high risk tolerance, just 10% in such safe assets is sufficient.

Why short-term Treasurys, specifically? They minimize risk due to their very low credit and interest rate risk, thanks to their structural characteristics. These securities are considered among the safest investments because they are backed by the full faith and credit of the U.S. government and their short duration reduces their sensitivity to changes in interest rates.

For practical implementation, you could create a short-term Treasury ladder or continuously roll over Treasury bills. Alternatively, for simplicity and cost-effectiveness, you might consider ETF options like the SPDR Portfolio Short Term Treasury ETF (SPTS), which has an expense ratio of just 0.03%.

This ETF tracks the Bloomberg 1-3 Year U.S. Treasury Index, featuring an average duration of 1.84 years and a yield to maturity of 4.57%, offering a straightforward and economical way to maintain this component of a Buffett-inspired portfolio.

Historical Performance

Here's how Warren Buffett's 90/10 portfolio would have performed from 1991 to present, using historical data from equivalent Vanguard mutual funds. Results are with all dividends reinvested and annual rebalancing.

It's important to recognize that this is a high-risk strategy. For instance, during the 2008 financial crisis, the portfolio experienced a 50% drawdown, and it has exhibited an annualized volatility of 16.21%. This level of fluctuation means the portfolio’s value can swing dramatically.

The allocation of 10% in Treasurys, while providing some cushion, doesn’t significantly mitigate overall risk. It’s crucial to understand that the minimal Treasury component primarily serves as a safe reserve rather than a major risk buffer. Therefore, the heavy weighting in equities exposes the portfolio to substantial market risk, which can lead to significant losses during downturns.

If you find the volatility and potential drawdowns of the 90/10 portfolio too hairy, consider adjusting the balance towards a higher allocation in Treasurys. Increasing your bond allocation can effectively reduce portfolio volatility and provide a greater buffer against market downturns.

Remember, while this strategy aligns with Buffett's recommendations, your individual risk tolerance and investment goals should guide your asset allocation decisions. If a 90/10 split feels too aggressive, tweaking the portfolio to include more bonds could be a prudent move.