Warren Buffett’s Way to Invest for Retirement

Warren Buffett has advised his wife to invest her bequest 90% in stocks and 10% in bonds—and this asset allocation mix could work for retirees, according to a study.

Javier Estrada of the IESE Business School in Barcelona argued the 90/10 allocation to low-cost S&P 500 index funds and short-term government bonds is “not only simple, but also sound.”

“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,” Buffett wrote in his 2013 letters Berkshire Hathaway shareholders.

According to Estrada’s paper, Buffett’s suggested asset allocation recorded a very low failure rate—the likelihood of the retiree running out of money prematurely—of 2.3%, below the acceptable rate of 5% for most retirees.

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The asset mix also provided a “middle ground between the best-performing strategy (100/0) in terms of upside potential and the best-performing strategies (60/40 and 70/30) in terms of downside protection.”

Even in the worst 5% and 10% of retirement periods during the studied 115-year period between 1900 and 2014, the 90/10 allocation only slightly underperformed the 60/40 and the 70/30, the paper said.

Furthermore, adding dynamic changes to Buffett’s advised allocation could improve on the 90/10 and 60/40 allocations, Estrada said.

When stocks do well, retirees should take the annual withdrawal from stocks and rebalance the rest of the portfolio back to the 90/10 allocation, the paper said. On the other hand, when bonds outperform, retirees should withdraw from bonds but not rebalance the portfolio.

“Withdrawing from bonds when stocks have performed badly, in absolute or relative terms, buys the time the stocks need to sooner or later stage their recovery,” the paper said.

These changes could provide higher upside potential and better downside protection, Estrada added, without having to process “vast amounts of information” other than the stock market’s performance.

Pension funds with even a limited amount of capital should be investing in private equity, argues a recent research note from Cambridge Associates.

While private investments can entail higher fees, illiquidity, complexity, and a lack of transparency, the research showed that they also offer opportunities for increased returns, greater diversification benefits, and dampened volatility.

The average private equity allocation among US corporate and public defined benefit pension funds is 5.5%, according to the report, leaving an opportunity for many pension funds to increase their private market allocations.

According to Cambridge Associates, private equity strategies—including venture capital, growth equity, buyouts, and debt-related and real assets strategies—outperform public equities over the long term, even after fees, expenses, and carried interest are subtracted from returns. The Cambridge Associates Global Private Equity/Venture Capital Benchmark has generated long-term returns exceeding public equities by 300 bps or more.

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By the consulting firm’s estimates, a pension fund that shifted 15% of its assets from public to private equities could boost its total return by 45 bps per year.

However, because dispersion between manager returns is “substantial,” manager selection and portfolio construction are essential to capturing returns, the report said.

Additionally, the research showed that the typical private investment fund takes six or seven years to produce meaningful results. Therefore, it is necessary for investors to maintain a long-term mindset.

Other characteristics of private investments, such as complexity and lack of transparency, can require more monitoring and governance than investments in public equities. However, Cambridge Associates argued the return potential of private equity merited the additional resources and effort.

private investments Source: Cambridge Associates