By TJ Porter, WCI ContributorInvesting is one of the most effective ways to build wealth in the long term. One of the most difficult parts of investing is figuring out how to invest your money. Determining your risk tolerance and the proper asset allocation for your goals is key to success. The 90/10 investment rule is a rule of thumb that some investors use when constructing their portfolio.
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90/10 Investment Rule Basics
The 90/10 investment rule is a rule of thumb for setting up your investment portfolio. The rule is relatively simple, advocating for splitting your portfolio, placing 90% of your assets into a low-cost S&P 500 index fund and the remaining 10% into short-term government bonds.
The rule was first mentioned by Warren Buffett, the CEO of Berkshire Hathaway and one of the best-known investors in the world. His acumen has allowed him to amass more than $100 billion in wealth, much of which he has donated to charity. In his 2013 letter to shareholders of Berkshire Hathaway, Buffett said, “What I advise here is essentially identical to certain instructions I've laid out in my will . . . 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.)”
The idea behind this strategy is that investors do not need to put much effort into managing their portfolio, pay relatively low fees, and have a diverse portfolio that holds many different stocks and bonds.
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Pros and Cons of the 90/10 Investment Rule
The 90/10 investment rule has several advantages, but it isn’t the right choice for everyone. It’s important to consider both reasons to use the 90/10 rule and reasons to consider alternatives before you commit to the strategy.
Pros of the 90/10 Rule
Simplicity
One of the biggest draws of the 90/10 rule is its simplicity. It’s very easy to understand the rule and to build a portfolio that will follow it. You can follow the rule by purchasing shares in just two different mutual funds. It’s also easy to rebalance your portfolio to ensure you maintain your desired 90/10 split.
Low Fees
Following the 90/10 rule is a good way to limit the fees you pay. Actively managed mutual funds often carry high fees and expense ratios. You could wind up paying 1% or more of your invested assets each year if you choose to invest in active funds.
Passively managed funds, like the ones that Buffett suggests, have much lower fees. For example, Vanguard’s S&P 500 mutual fund charges an expense ratio of just 0.04%. Over the long run, keeping your investing costs low can help boost your overall returns.
Greater Returns
In general, stocks have greater potential returns than bonds. The 90/10 portfolio’s large allocation of stocks means that it will, over the long run, tend to perform better than a portfolio that has a smaller allocation of stocks.
Between 1926 and 2022, a 90/10 portfolio produced average returns of 9.9%. By comparison, an evenly split 50/50 portfolio produced returns of 8.1%, a significantly lower amount.
Higher Volatility
A drawback of the 90/10 rule is that it calls for a portfolio that is mostly composed of stocks, which can lead to greater volatility. While stocks tend to perform better in the long run, stocks—over the short term—can see much greater dips in price than bonds.
For example, between 1926 and 2022, the worst year for a 90/10 portfolio saw it lose 39% of its value. By comparison, a 50/50 portfolio’s worst year saw losses of just 22.5%, a bit more than half as bad.
No International Exposure
The 90/10 portfolio offers simplicity by focusing solely on the S&P 500 and US government bonds. However, that simplicity also exposes a weakness in the strategy by ignoring international stocks and bonds.
It’s true that the United States has an outsized influence on the global economy. Its market makes up more than 60% of the world’s stock market. Still, that means that more than one-third of the global market is located outside of the US. Ignoring international investments could mean missing out on rapidly growing developing countries, lowering overall returns.
No Exposure to Alternative Investments
The 90/10 portfolio only includes allocations for stocks and bonds. While these are two of the most popular asset classes for most investors to focus on, there are other things that people can invest in: like real estate, precious metals, commodities, and cryptocurrency.
While most investors should likely focus on standard investments, like stocks and bonds, adding small amounts of alternatives to your portfolio isn’t unreasonable.
A Less Aggressive Alternative — 100 Minus Your Age
The 90/10 investment rule is just one rule of thumb that investors use to determine their desired asset allocation and portfolio. There are other popular ideas that you may want to consider.
Another popular rule of thumb for determining the right asset allocation is the 100 minus your age rule. The idea behind this rule is that if you subtract your age from 100, you’ll find the proper percentage of your assets that you should invest in stocks.
For example, if you’re 45 years old, you should have 55% (100 – 45) of your portfolio in stocks and the remainder, 45%, in bonds. The idea is that when you’re young, you can hold more of your money in high-volatility-but-better-performing stocks. As you age and get closer to retirement, you reduce your stock holdings to limit volatility.
Some argue that this rule is too conservative, and they have modified it to be the 110 or even 120 minus your age. Whatever number you use, it’s a quick and easy way to determine a good asset allocation.
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What’s Right for You?
The 90/10 investment rule is simple and easy to follow. It also has the potential to offer significant returns in the long run. However, you’ll also have to deal with major volatility in your portfolio and it ignores some investment types, such as international investments and alternative investments.
If your goal is a simple portfolio that’s easy to manage, the 90/10 rule offers that and comes recommended by one of the best investors in history. If you’re looking to build a more complicated portfolio that could offer more attractive performance or less volatility, consider other options.
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