how the 90 10 strategy works
for decades now warren buffett s annual chairman s letters have been eagerly awaited by his shareholders and countless investors eager to emulate his success his 2013 letter covered a variety of topics with a single paragraph devoted to the 90 10 strategy nonetheless that was sufficient to bring it to wide attention which continues to this day here is what he had to say an example of the 90 10 strategyan investor with a 100 000 portfolio who wants to employ a 90 10 strategy could invest 90 000 in an s p 500 index mutual fund or exchange traded fund etf with the remaining 10 000 going toward treasury bills treasury bills or t bills are short term debt issued by the federal government with maturities of up to one year 2 they can be purchased directly from the government through brokers or in the form of a mutual fund or an etf like treasury notes and bonds which have longer maturities they are generally considered the safest of all investments to calculate the performance of a 90 10 portfolio you would multiply each portion by its return for the year for example if the s p 500 returned 10 for the year and treasury bills paid 4 the calculation would be 0 90 x 10 0 10 x 4 resulting in a 9 4 return overall exchange traded funds or etfs work much like mutual funds but are traded on stock exchanges like stocks keeping fees to a minimumone reason buffett advocates investing through index funds is that they typically have rock bottom costs that s because they are passively managed rather that employ investment managers to make decisions on which stocks to buy and when to sell them these funds simply try to replicate a particular stock index like the s p 500 which is based on the stocks of 500 major u s corporations in addition numerous studies have shown that few investment managers can beat the performance of an index in any given year and fewer still can do it year after year 3that doesn t mean all index funds are alike some do a better job than others at keeping their costs down so in choosing among s p 500 index funds you should consider both their performance which is likely to be pretty close and their annual expense ratios which may be significantly different all else being equal a fund with the lower expense ratio will be a better deal in addition some mutual funds typically sold through brokers charge sales commissions or loads when you invest that will immediately take a cut out of your investment you can avoid commissions by buying no load funds directly from the fund company or from a discount broker that offers them criticisms of the 90 10 strategythe primary criticism of a 90 stock and 10 bond allocation is its high risk and potential for extreme volatility by contrast another well known strategy suggests subtracting your age from 110 and putting that percentage into stocks with the rest going into bonds at age 40 for example that would mean 70 stocks 30 bonds at age 65 it would be 45 stocks 55 bonds similar guidelines use 100 or 120 in place of 110 with such a heavy concentration in stocks the 90 10 portfolio is exposed to market fluctuations and can experience significant short term losses during market downturns this can be emotionally challenging for investors and may not be suitable for those with a low risk tolerance or a shorter investment horizon as financial writer walter updegrave put it in a 2018 column what i believe is the major question anyone thinking of adopting this strategy needs to resolve before adopting it will you be willing and able to stick with such an aggressive stocks bonds mix when the markets are in turmoil or even in the midst of a harrowing tailspin 4that s an especially pertinent question for anyone nearing or already in retirement 