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Dispatches

Retiree Portfolios and Warren Buffett’s Allocation Instructions

A test of Warren Buffett’s instructions for allocating the cash bequeathed to his wife (10% in short-term government bonds and 90% in a S&P 500 index fund) showed that it has historically worked well for retirees who were willing to cope with higher levels of volatility.

Warren Buffett’s instructions for allocating the cash bequeathed to his wife are 10% in short-term government bonds and 90% in a S&P 500 index fund. This simple allocation, though aggressive, has historically worked well for retirees who were willing to cope with higher levels of volatility.

Business school professor Javier Estrada tested Buffett’s suggested allocation globally using rolling 30-year retirement periods between 1900 and 2014. Because Buffett did not list any specific guidelines for how to implement and follow the suggested allocation, Estrada made a few assumptions. He used a 4% withdrawal rate, with the initial withdrawal rate adjusted upward for inflation. Withdrawals were made proportionately to the target allocation. The portfolios were rebalanced back to the 90/10 allocation after the withdrawals were made.

Failure—defined as outliving one’s savings—occurred during 28.1% of all 30-year periods across the 21 countries studied. In the United States, a retiree would have outlived savings during 2.3% of all 30-year rolling periods. (The failure rate was 0.0% for a 60/40 allocation.)

The variance of returns—as measured by standard deviation—increased as the proportion allocated to stocks rose, and fell as the allocation to stocks fell. This implies that a retiree takes on greater wealth uncertainty with a higher allocation to stocks. Nonetheless, wealth at the end of the 30-year periods (“terminal wealth”) was highest with the most aggressive allocations to stocks, a finding that held true for both the best and worst 30-year cycles. Though retirees bore greater uncertainty in terms of return with higher allocations to stocks, they were rewarded with higher levels of terminal wealth.

Estrada also tested a modified version of the 90/10 allocation strategy. Withdrawals were made either from stocks or from bonds depending on the five-year annualized return of stocks. If the five-year return of stocks was above the annualized return of stocks from the start of retirement to the current year, withdrawals were made from stocks and the portfolio was rebalanced. If not, withdrawals were made from bonds and the portfolio was not rebalanced. This tweak resulted in volatility and downside risk nearly identical overall to the aforementioned approach, while providing higher terminal wealth during good periods.

“Global Asset Allocation in Retirement: Buffett’s Advice and a Simple Twist,” Javier Estrada, SSRN, July 2016.

Discussion

William from CA posted over 9 years ago:

Food for thought... Taken to the limits, if everyone just goes with an "average", then - voila - we have a non-market, market. Something to mull: http://www.bloomberg.com/news/articles/2016-08-23/bernstein-passive-investing-is-worse-for-society-than-marxism?cmpid=yhoo.hosted Can everyone just be "average" and end up a winner? There just may be an ETF / indexing bubble, for real. Its heading that way, IMHO.


John Perry from PA posted over 9 years ago:

Maybe Buffett and family are wealthy enough not to worry about taxes or maybe given their nationwide self - described political leanings they enjoy thrusting money at inefficient and wasteful Leviathan. However, my portion of bonds will be invested specifically in high grade tax free municipals.


DwarkaR from USA posted over 9 years ago:

what is best tax free municipal ETFs you can suggest


Charles Rotblut from IL posted over 9 years ago:

DwarkaR, You can find information on all U.S. muni bond ETFs in our ETF Guide. -Charles


Mitchell Meyers from AE posted over 9 years ago:

Buffet's Brilliant. His surviving family members can easily get by just off dividends from an S&P 500 index fund, even if it gets cut in half during the next economic crisis. They won't panic, and won't have to sell at the very worst time. For a better appreciation of his mindset, read "Rich Man, Poor Man" at: http://dowtheoryletters.com/Content_Free/2494.aspx By not having to sell any stocks, they would incur no capital gains taxes, and would waste none of their precious time trying to time or out game an increasingly efficient market. Recommending Vanguard and the S&P 500 is also good for his image as an American capitalist, and as part of his legacy.


Dave Gilmer from WA posted over 9 years ago:

I have found in my own testing that by going to 80/20 that is all you really need to do to survive any 30 year period. In fact you will survive most 40 year periods as well.


Dave Gilmer from WA posted over 9 years ago:

But really I don't think any of us need to give advice to Buffett's family!


P Rathinasamy Pa from FL posted over 9 years ago:

Mrs.Astrid Buffett's inheritance is likely to be so huge that I will postulate that her annual living expenses, even if it were to go up, will not need the usual 4% draw as it is for an average American. The lesson I learned from his instruction to her trustee to leave all her portfolio in a 90/10 split of S&P590 and Short Term Govt Bonds is that he thought even his own Berkshire Hathaway shares ( no dividends/ single company risk- inspite of its immense diversified holdings), were too much of a risk for his wife after him. IMHO


P Rathinasamy Pa from FL posted over 9 years ago:

S&P 500 I meant.


Gordon Robinson from NC posted over 9 years ago:

If withdrawals are made from the Short Term Bond Fund in the years that the market was down the previous year the concept is the same as Jim Cloonan's Investing at Level 3. Exactly the same: Have a small, safe pool to withdraw from in down years and put all the rest in equities Jim Cloonan and Warren Buffet think alike


Gordon Robinson from NC posted over 9 years ago:

If withdrawals are made from the Short Term Bond Fund in the years that the market was down the previous year the concept is the same as Jim Cloonan's Investing at Level 3. Exactly the same: Have a small, safe pool to withdraw from in down years and put all the rest in equities Jim Cloonan and Warren Buffet think alike


Samuel Shepard from LA posted over 9 years ago:

to P Rathinsamy Pa from Fla: Your minor typo S@P 590 (500) was of no consequence. I made a similar mistake on Expedia booking a flight with United airlines (wrong date, Sat vs Sun) and United charged me $200 penalty. This was 10 days before the flight. DONT FLY UNITED IS MY ADVICE. A RIP OFF. Samuel Shepard from LA


Jeff from NY posted over 9 years ago:

It would have been great if the study had also been conducted for shorter retirement periods. A 30 year window is great for people who retire at 55 but for those who wait, a shorter time would be appropriate. It would seem that studying other time intervals would be relatively easy, so it makes me uncomfortable that they were not reported. In addition, we should recognize that this is a retroactive study. While many people assume that things will be the same in the future, that is not always true.


Ralph Rice from NJ posted over 9 years ago:

Securities are the foundation of of wealth development Your work is to find stocks that allow for few sleepless nights and your attention to physical activities which will keep your the noise of the market.


Vaidy Bala from AB posted over 9 years ago:

I give my opinion large investments by Buffett style are not applicable for investors, one size does not fit all. Each one has to to with due diligence what is most appropriate with good investment knowledge and trends and make the most. Markets do and will fluctuate and cannot be predicted. Volatility is the Market, there is no safe haven!


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