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Warren Buffett’s Advice to His Heir’s is Wrong

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Warren Buffett’s Advice to His Heirs

Here’s Warren Buffett’s advice for investing – to his heir’s. It’s great advice – just not for you.

“My advice to the trustee couldn’t 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.” ~ Warren Buffett, Berkshire Hathaway 2014 letter to shareholders (page 20)

Warren Buffett is arguably one of the best investors that has ever lived. His iconic Berkshire Hathaway fund (NYSE: BRK.A), currently trading at $301,160, earned an annualized return of  20.9% between 1965 and 2017. That’s in contrast with the respectable 9.9% performance of the S&P 500 during that same period. (As reported in his 2017 Berkshire Hathaway annual letter to shareholders.)

So why in the world is he advising the executors of his estate to invest 90% of the proceeds in an S&P 500 index fund, instead of his Berkshire Hathaway stock? 

Learn; 8 Steps to Creating a Diversified Asset Classes Portfolio with Index Funds

After all, Buffett and his partner Charlie Munger hired top-notch managers to run the company upon their deaths. Doesn’t Buffett have faith in his successors? Even Munger is sticking with Berkshire Hathaway for his heirs. 

Why Buffett Recommends Index Funds for His Heirs

Buffett clearly explains why he recommends index funds. He believes in the strength of U.S. businesses and expects them to continue to prosper. Buffett also discussed in his 2014 shareholder letter his fear that stock picking investors would shoot themselves in the foot when markets drop. (Ok, he didn’t say that exactly, but, the idea was there.)

“The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs’ observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period (dollar cost averaging) and never to sell when the news is bad and stocks are well off their highs.” ~Warren Buffett, Berkshire Hathaway 2014 letter to shareholders (page 19)

He believes that the S&P 500 includes a well-diversified group of businesses that are bound to do well over the long term. 

Warren Buffett’s advice is to capture the returns of these businesses by keeping fees low – thus the index fund. If companies continue to grow and prosper then the stock market performance will be good. 

Click to learn how to put into action an index fund investment strategy.

In fact, Buffett’s opinion coincides with the bounty of research that states most investors, actively managed mutual funds and financial professionals fail to beat the S&P 500 stock market index. Recent S&P research found that between 2012 and December 29, 2017, 84.23% of large-cap funds failed to beat the returns of the S&P 500. 

“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 says.

And that’s why Warren Buffett’s advice is to invest in low-fee index funds.

Why Buffett’s Advice to His Heirs isn’t Right for You

Don’t get me wrong, I love index funds. In fact, I’ve gone from a stock picker to an index fund investor. So, why do I think Buffett’s advice to his heirs is wrong?

Read; Why I Don’t Invest in Individual Stocks Anymore

Actually, it’s not all wrong, just partially wrong. 

First, the asset allocation of 90% stocks and 10% in short-term government bonds is too extreme. 

Imagine what would happen to your portfolio should the stock market crash and drop 36.55% like it did in 2008. Or, how would you feel if the stock market dropped 21.97% like it did in 2002? Could you ride it out without selling? 

With Buffett’s 90%-10% stock/bond allocation, if you had a $500,000 portfolio invested 90% in an S&P 50 index fund and 10% in short-term Treasuries, your investments would be worth $411,500 after a 20% stock market drop. This assumes that Treasuries returned 3%.  That’s a one-year loss of $88,500 or approximately 17% for your investment portfolio. 

Watching tens of thousands of dollars vanish in one year is a tough pill to swallow.

Warren Buffett's advice to his heirs is wrong - find out why.

A 90% stock and 10% treasury portfolio is an extreme asset allocation for the average investor. Sure, with a 90% stock, 10% treasury allocation you would maximize your gains during well performing years, but during those occasional down stock markets, you’d experience huge losses. 

Warren Buffet’s widow will have more than enough money to withstand extreme stock market volatility. But most of us don’t.

That’s why most investment risk quizzes recommend a more moderate stock vs. bond asset allocation. Because the average investor can’t sit tight and tolerate the pain of a huge stock market drop.

So, in contrast with Buffett’s advice, most investors should temper their asset allocation towards a more balanced stock vs. bond allocation. If you’re young and an aggressive investor, 90% stock and 10% treasuries might be ok, but for the rest, lighten up on the stock holdings and invest a bit more in the fixed investment category. 

Bonus; 5 Inspiring Warren Buffett Quotes

Second, you might want to broaden your stock and bond fund holdings. 

The U.S. is approximately 50% of the world’s stock market. And, we’re a mature market with many older companies. In general, newer, smaller firms grow faster and deliver higher returns than old stalwarts. So, investors should take a look at international stock funds and possibly small-cap funds as well. 

You might want to consider an international index fund with exposure to both developed and developing markets such as Vanguard’s All-World ex-US ETF (VEU). This index fund has a low expense ratio of 0.11% and gives you exposure to companies around the world, many of which are growing faster than those in the U.S.

If you want to diversify further, there are countless other index fund varieties that cover various segments of the stock and bond markets, all sporting low management fees.

Now, I’m not suggesting that you buy 10 diversified low-fee index funds, but a few more than two might pump up your returns and give you a bit more diversification should the U.S. stock market fall while the rest of the world market’s hold steady.

Our family invests in REIT, small cap, value and international stock index funds along with several types of bonds. 

Warren Buffett’s Advice Wrap Up

Index fund investing is clearly the best strategy for most investors. With low fees and great diversification, you’ll likely beat most active fund managers, as long as you hold on for the long haul. For those without a steely stomach, tweak your asset allocation to hold 60% to 85% stock funds and the rest in bond funds. 

Warren Buffett’s advice is perfect for his heirs, but you might want to adjust it a smidge to fit your personal investing. And whatever you do, don’t let fear cause you to jump out of the markets after a decline. You just might miss the next bull market. 

 

    2 Comments

  1. Less stock exposure limits the risk of for sure. But it also limits the potential profits.

    I think it comes down to how many years you have until you retire. The younger you are the more stocks you can have in your portfolio.

    Warren also says “Time in the market” beats “trying to time the market” which I tend to agree on.

    Financially Free

    August 7, 2018

    • Well put! For younger investors, higher proportions of stock market investments will give you a chance for greater returns (should historical trends continue). In fact, I wish I was a bit more aggressive in my investing in my 20’s and 30’s.

      Barbara Friedberg

      August 7, 2018

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