90/10 Investing Strategy: Definition, How It Works, Pros & Cons

What Is the 90/10 Strategy?

Legendary investor Warren Buffett proposed the "90/10" strategy in his 2013 chairman's letter to Berkshire Hathaway shareholders. The strategy calls for putting 90% of one's investment capital into low-cost stock index funds and the remaining 10% in low-risk government bonds.

It differs from many common investing strategies that suggest lower percentages of stocks and higher percentages of bonds, especially as the investor gets older.

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:

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) 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. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, or individuals—who employ high-fee managers.

An Example of the 90/10 Strategy

An 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. 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.

Keeping Fees to a Minimum

One 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.

That 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 Strategy

The 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?"

That's an especially pertinent question for anyone nearing, or already in, retirement.

The Bottom Line

A 90/10 investment allocation is an aggressive strategy most suitable for investors with a high risk tolerance and a long time horizon. While Warren Buffett has an enviable track record as an investor, it probably isn't for everyone.