The Warren Buffett 90/10 ETF Portfolio (Canadian Investor Edition)

Buffett is a legendary value investor and the chairman of Berkshire Hathaway (BRK.A, BRK.B), which he turned from a struggling textile mill into a powerhouse conglomerate, delivering returns that consistently beat the market for decades.

Interestingly, while Buffett is famed for his acute stock selection skills, he also shared some prudent advice for the everyday investor in his 2023 shareholder letter. Discussing his plans for his estate after his passing, Buffett gave this 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.”

While I maintain a healthy skepticism of authority bias, this approach seems quite sensible for many. In today's guide, I'll analyze why this strategy might be effective and suggest ETFs you could use if you're interested in implementing Buffett’s straightforward investing method.

For Canadian investors, this strategy is still straightforward but requires a slight modification to incorporate Canadian ETFs, rather than a direct replication. This adjustment allows us to follow Buffett's original plan while adapting it to the Canadian investment landscape.

Why the S&P 500?

Warren Buffett's endorsement of the S&P 500 isn't without reason. He's a firm believer in the potential of U.S. stocks, and the S&P 500 serves as a robust, well-regarded benchmark that reflects the performance of the U.S. large-cap market.

The S&P 500 also boasts strong performance metrics. 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, a trend often linked to higher fees and turnover rates.

The S&P 500 is particularly appealing for long-term investors due to its low turnover rate of just 2%. Low turnover is beneficial as it minimizes trading costs and allows the fund to capitalize on the 'let winners run' philosophy inherent in market-cap weighted indexes.

In this setup, while the strategy might miss out on mid-caps, small-caps, and international exposure, the focus is on leveraging ultra-low fees and minimal turnover to generate solid returns, with a secondary emphasis on maximum diversification.

For those looking to gain exposure to the S&P 500, there are many options. While Buffett has often favored Vanguard products, Canadian investors might consider the BMO S&P 500 Index ETF (ZSP) which has a management expense ratio (MER) of 0.09%.

However, it's important to note that with ZSP, you'll lose 15% of dividends to withholding tax, and it's also subject to currency risk—gains if the USD strengthens against the CAD, and losses if the CAD appreciates.

Why short-term Treasurys?

The allocation of 10% to short-term Treasurys in Warren Buffett's investment strategy is deeply rooted in his cautious approach to investing. In a 1979 shareholder letter, Buffett voiced his concerns about long-term, fixed-interest bonds denominated in dollars, particularly in an environment where the dollar's value seemed likely to diminish. 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."

His skepticism was echoed in 2022 when long bonds with high durations suffered significant losses due to rising interest rates, experiencing even deeper drawdowns than stocks. While long-term bonds still play a role in diversified portfolios, their sensitivity to interest rate fluctuations may not suit novice investors.

Buffett’s inclination towards short-term bonds, specifically Treasury bonds, is aimed at maintaining a "safe reserve." This allocation serves as a financial safeguard, providing liquidity to seize asset acquisition opportunities at lower prices or to ensure financial security for his wife after his passing. Given his risk tolerance, a mere 10% in such secure assets is deemed adequate.

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

For those in Canada looking for a practical implementation, consider the BMO Short Federal Bond Index ETF (ZFS). Opting for a Canadian-domiciled Treasury ETF is sensible, especially since our government holds a credit rating nearly as robust as that of the U.S. government.

ZFS features a 0.22% expense ratio, a weighted average yield to maturity of 2.94%, and a AAA credit rating, making it a viable and straightforward option for maintaining this component of a Buffett-inspired portfolio.

Historical Performance

Here's how Warren Buffett's portfolio would have performed from November 2012 to present, using a backtest of 90% in ZSP and 10% in ZFS with quarterly rebalancing. However, this impressive performance is somewhat of an anomaly, heavily influenced by currency fluctuations during the last decade.

Specifically, ZSP benefited from a rising U.S. dollar against a falling Canadian dollar. Since ZSP holds U.S. stocks but trades in Canadian dollars, the value of its holdings effectively increased as the U.S. dollar strengthened, boosting its performance when measured in Canadian currency.

In comparison, when I conducted a similar backtest for the U.S. version of this article, dating back to 1991 using Vanguard mutual funds, the resulting CAGR was 10.19%. This figure is considered far more realistic and indicative of expected performance without the added variable of currency tailwinds.