What is the 90/10 strategy (plain definition)
– The 90/10 strategy is a simple asset-allocation rule that directs about 90% of an investor’s portfolio into broad, low-cost U.S. stock index funds (commonly an S&P 500 fund) and roughly 10% into very safe government short-term debt (typically Treasury bills, or T‑bills). It was popularized by Warren Buffett in his 2013 letter to Berkshire Hathaway shareholders.
Key terms (definitions)
– Index fund: a pooled investment vehicle that tries to replicate the performance of a market index (for example, the S&P 500) rather than actively selecting stocks.
– ETF (exchange-traded fund): a fund that tracks an index or asset and trades on an exchange like a stock.
– Passively managed: a fund-management style that follows an index rather than using active security selection; usually lowers costs.
– Expense ratio: an annual fee (a percentage) charged by a fund to cover operating expenses; smaller expense ratios keep more returns for investors.
– Load / no-load: a load is a sales commission some mutual funds charge when you buy; no-load funds do not charge that fee.
– Treasury bills (T‑bills): short-term U.S. government debt securities with maturities up to one year; considered among the safest investments.
How the 90/10 allocation works (mechanics and formula)
– Break your portfolio into two pieces: 90% equities (an S&P 500 index mutual fund or ETF is a common choice) and 10% T‑bills or similar short-term government instruments.
– To compute a portfolio return for a single period, weight each asset class by its return and sum:
Portfolio return = 0.90 × (stocks return) + 0.10 × (T‑bills return).
– The strategy emphasizes low costs (low expense ratios and avoiding loads) and passive indexing because studies show few active managers consistently beat indexes.
Worked numeric example
– Starting portfolio: $100,000.
– Allocate $90,000 to an S&P 500 index fund and $10,000 to T‑bills.
– Suppose the S&P 500 returns 10% for the year and T‑bills return 4%.
Calculation:
– Stocks portion: 0.90 × 10% = 9.0%
– T‑bills portion: 0.10 × 4% = 0.4%
– Total portfolio return = 9.0% + 0.4% = 9.4%
– End value = $100,000 × (1 + 9.4%) = $109,400.
Advantages (why investors use it)
– Simplicity: one rule, easy to implement.
– Growth focus: heavy equity weight aims to capture long-term stock-market appreciation.
– Low-cost emphasis: using passively managed index funds and avoiding loads keeps fees small and can improve net returns.
Main criticisms and risks
– High volatility: 90% in stocks exposes the portfolio to large short-term swings and potentially big losses in downturns.
– Emotional and timing risk: investors must be willing and able to stay invested through severe market drawdowns; that can be difficult for people near retirement or with low risk tolerance.
– Not tailored by age or liquidity needs: it departs from age-based rules that shift toward bonds as investors age (for example, “110 minus age” or similar variants).
Common alternatives (brief)
– 60/40 portfolio: 60% equities and 40% bonds — a more traditional balanced approach that aims to reduce volatility by holding a larger bond allocation.
– Age-based rules: simple heuristics like “110 minus your age” to set equity exposure (e.g., at age 40: 70% stocks, 30% bonds).
Practical checklist to implement a 90/10 approach
1. Confirm suitability: assess your time horizon and tolerance for swings in portfolio value.
2. Choose a low-cost broad U.S. equity index fund or ETF (S&P 500 is a common choice).
3. Select a T‑bill vehicle: direct T‑bills, a T‑bill ETF, or a Treasury money market fund.
4. Compare expense ratios and avoid funds with sales loads.
5. Buy through a low-cost broker or directly from the fund company to minimize fees.
6. Decide on a rebalancing rule (time-based or threshold-based) and stick to it.
7. Monitor but avoid reacting to short-term market noise.
Notes on fees and vehicle selection
– Small differences in expense ratios compound over time. All else equal, prefer funds with lower annual fees.
– Avoid funds that charge front-end sales commissions (loads); use no-load funds or discount brokers.
Who might favor the 90/10 allocation
– Investors with long time horizons and high risk tolerance who prioritize long-term growth and can stay invested through major downturns.
– Not generally recommended for investors needing stability, predictable income, or those near or in retirement unless they can emotionally tolerate large drawdowns.
Rebalancing (brief practical guidance)
– The original description does not mandate a specific schedule. Common approaches include periodic rebalancing (for example, annually) or rebalancing when allocations drift beyond a preset threshold (for example, +/- 5 percentage points). Choose a method beforehand and apply it consistently.
Summary (bottom line)
– The 90/10 strategy is a straightforward, aggressive allocation that leans heavily on equities for long-term growth while keeping a small safety allocation in T‑bills. It’s inexpensive and simple but exposes investors to substantial volatility and requires discipline to maintain through market downturns.
Selected sources for further reading
– Investopedia — 90/10 Strategy overview: https://www.investopedia.com/terms/1/90-10-strategy.asp
– Berkshire Hathaway — Warren Buffett’s 2013 shareholder letter: https://www.berkshirehathaway.com/letters/2013ltr.pdf
– U.S. Department of the Treasury — Treasury bills: https://home.treasury.gov/policy-issues/financing-the-government/treasury-securities/treasury-bills
– Vanguard — Introduction to index investing and ETFs: https://investor.vanguard.com/investing/how-to-invest/indexing
Educational disclaimer
This explainer is for educational purposes only and does not constitute personalized investment advice or a recommendation to buy or sell any security. Consider consulting a qualified financial professional before making allocation decisions.