Warren Buffet: One of the world’s richest men, perhaps its greatest living investor, a global philanthropist, sage, paragon of modesty, and a damn fine letter writer to boot. If I had my way this guy would be on posters on every street corner as the West’s answer to North Korea’s Dear Leader.

To cap it all, Buffet loves passive investing, as previously noted by The Investor.

So much so that his instructions for his legacy to his wife are to invest the bulk of the money in index funds:

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. (VFINX)) 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.

Talk about keeping it simple!

Warren Buffet's passive portfolio

So how would you translate Buffett’s advice into a passive portfolio that UK investors could buy?

Like this:

Asset class Fund Allocation (%)
Equities Vanguard US Equity Index Fund 90
Short-term government bonds Vanguard US Government Bond Index Fund 10

The US Government Bond fund is hedged to Sterling. 66% of its securities count as short-term.

Of course that’s all well and good for someone who lives in America, or plans to emigrate.

A UK homebody version would look like this:

Asset class Fund Allocation (%)
Equities Vanguard FTSE UK Equity Index Fund 90
Short-term government bonds (gilts) SPDR Barclays Capital 1-5 Year Gilt ETF 10

Note: See our cheap tracker guide.

The snag is that the UK equity market isn’t as large or as diversified as the US.

Britishers are well advised to go global:

Asset class Fund Allocation (%)
Equities Vanguard FTSE All-World ETF 90
Short-term government bonds (gilts) SPDR Barclays Capital 1-5 Year Gilt ETF 10

Note: See our cheap tracker guide.

That’s a very simple portfolio that’s poised to take advantage of the march of global capitalism.

Over the long run you should benefit from the high expected returns of equities. Yet you must be prepared to endure the trauma of heavy losses along the way when you devote 90% to a risky asset.

A passive investing champion like Larry Swedroe would generally only recommend a 90% equity allocation if 15 years or more of investing lies ahead of you.

Over that kind of longer time horizon, equity returns are more likely (but not certain) to average out to something that resembles their historical record.

Asset allocation decisions

My guess is that the Buffet passive portfolio can afford to invest 90% in risky equities because Mrs Buffet will not rely upon the stock market portion for her essential living expenses.

The chances are that the bequest is big enough to cater for the basics purely from the government bond portion.

If that’s the case then the portfolio’s asset allocation reflects the fact that you can take more risk on the equity side – in the hope of better returns – as long as you’re not banking on those returns to enable you to live.

If you don’t need the money soon, or you have other options – such as property to sell, a reliable income from other sources, or the ability to get another job – then you can afford to take more risk, too.

In that instance, your age doesn’t matter, although your risk tolerance does.

The less you can afford to lose or the fewer options you have or the sooner you’ll need the money, the more you should ramp up your bond allocation.

Risk free return or return free risk?

Warren Buffet is as sceptical as anyone about the prospects for bonds but plainly he knows that short-term government bonds are a good source of liquidity.

Short-term government bonds:

  • Are unlikely to default (in the case of UK and US bonds).
  • Perform well during turbulent market conditions.
  • Do okay against inflation or rising interest rates (when in a fund) as they mature quickly and are reinvested at a better rate.
  • Are low volatility (in other words, you’re extremely unlikely to find the value of your bonds halves just when you need the money).

Short-term government bonds generally offer stability and low growth and are the bungee in your portfolio that slows its decline in value when equities plunge. They can protect a portion of your nest egg when you need to crack it open, meaning that bonds are still worthy of a place in most portfolios, despite ongoing nervousness about interest rates.

Whether the exact detail of Buffet’s passive portfolio is for you is beside the point. It’s the underlying principle that counts: If passive investing is good enough for his nearest and dearest then it’s probably good enough for the rest of us.

Take it steady,

The Accumulator

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