Warren Buffett 90/10 Strategy

In a 2013 letter to Berkshire Hathaway Shareholders Warren Buffett said that upon his passing, he would be instructing his wife to put 90% of his cash into a low-cost market index fund i.e. VOO or VTI, and 10% into short-term government bonds. I have discussed before how a high stock market allocation is the biggest factor in determining your long-term gains. But I have also discussed how some exposure to a low-volatility bond fund can help to reduce your portfolio fluctuations.

With the bond fund we could use the same one that I used in my Couch Potato Portfolio, i.e the SHY, which has a beta of 0.24. Or we could use TIPS (Treasury-backed Inflation Protected Securities). SHY has lower volatility with a beta of 0.24 vs. 0.66. SHY has a yield of 3.9% vs. TIPs with a yield of 2.8%. Over the last 22 years, TIPs have had a slightly better capital gain than SHY. Basically, SHY have held to their low volatility (beta) and have flat lined, whereas TIPs have had a few more ups and downs. Because we want to use our 10% bond portion to reduce volatility, I am leaning towards using SHY in my portfolio. But when an S & P 500 ETF is back tested for 20 years, complemented with either a short-term/ intermediate-term or long-term bond ETF, the 10% TLT (long-term bond) allocation was shown to be the best. Other than in 2022, when bonds declined along with stocks, the TLT has had a low correlation to the S & P 500. And it is this low correlation, combined with the higher volatility, which is why the 90:10 portfolio of VOO and TLT is the best mix.

Long-term bonds normally have better yields, because the investor in the underlying bond (s) is being rewarded for being locked into their investment for a longer period. Because TLT is an ETF though, which holds 100s of individual bonds within it, the risk having a longer-term maturity is mitigated by way of diversification. Over the last 22 years, TLT has shown to have very similar capital-gain returns to TIPs. Combine this with the higher yield, and the TLT has had a better long-term return than either TIPs or SHY. It has a beta of 2.33, which means that it is about twice as volatile than the equity market. But what mitigates this, is the uncorrelated returns to the S & P 500. It is really important in a balanced portfolio to have uncorrelated returns in your different asset classes. And in the case of VOO and TLT, this is exactly what you get. So, we will make a slight change to the Warren Buffett 90:10 portfolio, by having a 10% TLT allocation (instead of SHY), and we will stick with a 90% allocation to VOO.