I’m retired and living off withdrawals from my savings. I would like to simplify my portfolio, so I’m thinking of following a strategy Warren Buffett has suggested: put 90% of my money in a Standard & Poor’s 500 index fund and 10% in bonds. Good idea? –Mark, California
The strategy you mention comes out of a section of Warren Buffett’s 2013 letter to Berkshire Hathaway shareholders where he says his will stipulates that cash be delivered to a trustee for his wife’s benefit and that 90% of that cash go into a “very low cost” Standard & Poor’s 500 index fund and 10% into short-term government bonds. He doesn’t talk about retirement specifically. But when asked about the strategy in a later TV interview, he refers to withdrawals of 3% to 4% a year and notes that if there’s a terrible period in the market, one should draw from the bond stake to avoid selling stocks at a bad time.
I don’t think there’s any doubt that the 90-10 portfolio Buffett recommends for his wife can work for her and perhaps for certain other retirees looking to draw sustainable income from their nest egg. Indeed, a finance professor at Spain’s IESE Business School published a paper in October showing that in the 86 overlapping 30-year periods between 1900 and 2014, such a portfolio survived more than 97% of the time, or about as often as less aggressive portfolios, assuming annual rebalancing and an initial 4% withdrawal subsequently adjusted for inflation.
When I ran a 90% stocks-10% bonds portfolio through T. Rowe Price’s retirement income calculator, which uses Monte Carlo simulations based on projected returns rather than historical data, I got a somewhat lower success rate for 30 years: just under 80%. But as with the historical analysis, that success rate was largely in line with that for less stock-intensive portfolios.
Still, despite the 90-10 portfolio’s solid showing, I wouldn’t recommend it as the way to go for most retirees. The main reason: I doubt that most people relying on their savings to maintain their standard of living over a long retirement can emotionally handle the volatility that comes with such a high exposure to stocks.
It’s one thing to say that, faced with something like the near 60% decline in stock prices like we saw from late 2007 to early 2009 or a 10-year span like 1999-2008 when stocks lost an annualized 1.4%, you’ll just draw from the bonds in your portfolio and remain confident that the market will eventually recover as it has in the past and everything will work out fine. It’s another thing, though, to live through such periods and stick with such a big stake in stocks when you see the value of your life savings declining rapidly and all you hear is gloom and doom about the prospects for the market. I suspect that even if someone did manage to stay the course, he or she might have trouble enjoying retirement while waiting for stocks to rebound.
Another reason I can’t recommend the 90-10 approach for most retirees is that you don’t have to invest so aggressively for your nest egg to support you 30 or more years. You can get comparable, if not better, success rates with portfolios that have much less in stocks. In the examples that I ran using the Monte Carlo retirement income calculator, a portfolio of 50% stocks and 50% bonds generated the highest success rate, 80%, and even a very conservative 30% stocks-70% bonds portfolio had the same chance of lasting 30 years as the 90-10 portfolio.
Of course, there is another advantage to going with a higher stock stake. In scenarios where the portfolio doesn’t run out of money, a portfolio with more stocks will tend to have a higher balance late in retirement than a portfolio with less stock exposure, which makes sense since stocks generally generate higher returns than bonds. So upping your exposure to stocks might be a better way to go if leaving assets to heirs is a high priority or you just like the idea of possibly having a bigger savings cushion that you can fall back on if necessary late in retirement. But it’s also important to remember that there’s no assurance that allocations that fared well in the past will do as well in the future and that projections aren’t guarantees. Similarly, there’s no free lunch. The more you up the ante in stocks, the more your portfolio’s value is likely to dip and dive.
So what’s the right allocation for most retirees? There’s no single answer. But in my view, your primary aim should be to arrive at a stocks-bonds mix that’s in line with your tolerance of risk. Take on more risk than you can psychologically and emotionally handle, and you may end up jettisoning stocks when things get bad, locking in losses. Invest too conservatively and you may be tempted to boost your stock holdings when the market’s doing well, which could leave you more vulnerable when the market eventually falters.
A good starting point for coming up with an appropriate stocks-bonds mix is filling out a risk tolerance-asset allocation questionnaire like the one Vanguard offers online. Based on your answers to 11 questions about your investment time horizon and ability to handle volatility, the tool will recommended a specific mix of stocks and bonds. It will also show you how that mix, as well as others more conservative and more aggressive, have performed in good and bad markets as well as over the long run.
My guess is that most investors who go through this exercise will end up, at least initially, with a portfolio that’s between 40% and 60% in stocks. But you can tailor that mix to your particular circumstances. For example, if you’ve got lots of other resources you can fall back on besides your retirement savings or your nest egg is so large that your chances of running through it are minimal, then you could increase your stock stake. (I expect that Mr. Buffett’s wife is probably in such a position.)
The same might apply if the Social Security payments you receive are large enough to cover all or most of your basic living expenses or if you have guaranteed income from an annuity.
You may want to trim your stock stake a bit, however, if the idea of seeing your nest egg’s balance dip precipitously in a crash frightens you or if you’ve got a relatively small savings stash and little else to support you if it’s whacked with a big loss. And since people tend to become less tolerant of risk as they age, you may also want to pare back your stock exposure gradually throughout retirement (although there’s also an argument for a “reverse guide path,” or starting with a relatively low stock exposure and increasing it later on).
Assessing how retirement portfolios consisting of different stocks-bonds mixes have fared in the past and might do in the future is certainly valid, but you’ve also got to live day in and day out with whatever allocation you choose. So your choice has also got to reflect the level of volatility and risk you can handle while still enjoying retirement. Which is why whatever theoretical appeal the Buffett 90-10 strategy may have, as a practical matter I think it’s a non-starter for the vast majority of retirees.
