By Ted Schwartz, CFP

In 2013, according to the online database Investopedia, Warren Buffett told investors that his wife’s trustee had simple instructions for investing her inheritance. The instructions were to invest 90% of her money in a low cost S&P 500 Index* Fund and 10% into short term US government bonds.

The question is-was this good and prudent advice for his wife’s trustee and more importantly, is this good advice for you or I to follow? It is hard to think of someone more likely to give us good investment advice than Warren Buffett.

Dr. Craig Israelsen has compared this simple Buffett portfolio to several other ideas and evaluated how they have done over the past 25 years in a recent article in Financial Planning magazine. He compared the strength of the Buffett idea to a traditional 60% U.S. stock and 40% bond portfolio, to just keeping cash, and to Dr. Israelsen’s own extremely diversified, global Seven Asset Portfolio (we have long been devotees of this last type of portfolio, though with modifications). He tested the portfolio including taking required minimum distributions each year for a retirement account. The Buffett portfolio did the best of the four, allowing the most withdrawals and the largest remaining balance after 25 years. The Seven Asset Portfolio and the 60%/40% portfolios had very similar results and the cash was the poorest choice. The only downside of the Buffett portfolio was its far higher volatility (i.e. it both rose far higher and fell far more than the other portfolios). So, you fared better but had to withstand some very uncomfortable drawdowns in bad markets.

Is our take away from this-as long as you can stand the volatility and not react by buying or selling anything in your portfolio, the Buffett portfolio is the way to go? Not so fast. Let’s remember the caveat at the bottom of most every page about investments- “past performance is not indicative of future results”. The past 25 years show that Buffett’s portfolio was a great idea and he believes it will remain a great idea for the next 25 years as well.

At Capstone, we do not believe we are smart enough to know how things will play out in the next 25 years, so we look to mitigate risk as much as possible through diversification. Will the United States remain the bell weather for the world economy? Will we continue to outperform other markets? Will stocks continue to provide the highest risk adjusted returns? Will we avoid calamities and black swan events that change our assumptions or potentially yield losses that are too big to live with?

Let’s take a moment to consider just how outsized the bet Buffett is recommending truly is. Almost all portfolios of Americans feature larger allocations to domestic U.S. stocks than towards international stocks. According to Y Charts, in 2017 the GDP of the US was 24.03% of the world GDP. So, you are already making an outsized bet on the US if your portfolio has equal weights of US stocks and International, as the US is less than a quarter of all economic activity. Perhaps, Buffett and his defenders will point out that US companies do a lot of business abroad and therefore, you get foreign exposure by owning US companies. Isn’t the same true in reverse? If you own European or Japanese stocks, don’t they have exposure to the US through their exports? Certainly, trade deficits would indicate that buying foreign stocks does increase your US exposure. So, it is putting your risk on steroids to put all of your eggs in the US basket, ignoring the other ¾ of the world’s economic activity.

We are not trying to be a doomsday prophet here. We are merely saying that unless we feel very sure that the future will more or less be like the past 25 years, we will be well served to mitigate our risk as best we are able and hope that some of our investments pan out over the long haul. New technology is often described as disruptive. We think that is a fair assumption as we look to the future and why we need to diversify our risks as much as possible. Things change and stuff happens. Otherwise, our retirement portfolio of blue chip stocks- Sears, A&P, Commodore Computer, Eastern Airlines, Lehman Brothers, Johns Manville, and Enron would still be performing admirably and we would be living the good life. OK, we never owned any of those stocks but….who saw those declines coming? Which pundits told you to stay clear of those companies in decades gone by?

The older I personally get, the more I think we give too much credence to “experts”. They suffer from the same problem of being influenced by the present that the rest of us do. In 1929, Yale economist Irving Fischer said, “Stocks have reached what looks like a permanently high plateau”. Listen to the professor at your own risk!

Be prudent, be surprised, learn what you can along the way. Don’t put too much stock in others when they are predicting the future. We never know when Yogi Berra will turn out to be prophetic when he said, “the future ain’t what it used to be.”

*The S&P 500 Index is an unmanaged index of 500 large US companies. It cannot be invested indirectly