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 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

In a 2013 letter to Berkshire Hathaway investors, Warren Buffett stated that the trustee of his wife’s inheritance was instructed to put 90% of her inheritance into a very low-fee stock index fund and the remaining 10% into short-term treasuries upon his passing. The allocation strategy is obviously heavily weighted in stocks, with short-term treasuries acting as a hedge.

I like to use this allocation strategy as a benchmark. It’s somewhat aggressive in terms of drawdown risk, but who am I to argue with the Sage of Omaha? His assertion that the performance of this strategy will exceed most investors returns over the long term is a challenge I’d like to take up with one simple amendment to the 90/10 allocation.

Recall Rule 2:

No single asset class shows strong performance across all regimes. Therefore, there isn’t a static portfolio weighting that is optimal across all regimes.

Therefore, let’s avoid an arbitrary split of 90/10. Instead, I’m going to use regime switching to determine the allocation. The 100/100 Regime Switching Portfolio is constructed such that allocations between SPY(1)low cost S&P 500 Index ETF) and SHY(2)low cost short-term treasuries ETF are binary. 100% of the portfolio is allocated to SPY except during Regime 4(3)Declining Growth, Rising Inflation periods when the allocation shifts into 100% SHY. I don’t want to be invested in the stock market when economic conditions are least favourable to stocks; that is, low growth and rising inflation.

Both portfolio’s use the same ETF’s. The only difference is that I’m not using a static portfolio weighting. Economic conditions dictate the most appropriate allocation.

What does the comparison look like?

 Buffett 90/10 Portfolio100/100 Regime Switching Portfolio
# Years:1414
Starting Equity: $1,000,000.00 $1,000,000.00
Ending Equity: $2,977,781.56 $3,535,729.95
Total Return: $1,977,781.56 $2,535,729.95
Total Return (%):197.78%253.57%
Compound Annual Growth Rate:8.11%9.44%
Profit Factor:1.721.99
Return/Drawdown Ratio:4.3110.84
Avg Annual Return (%):8.06%8.96%
Avg Monthly Return (%):0.67%0.75%
Standard Deviation (%):0.77%0.65%
Worst-case Drawdown (%):-45.88%-23.39%

The 100/100 Regime Switching Portfolio has better performance across the board. Of particular note is the dramatic reduction in drawdown, almost half compared to the 90/10 Portfolio benchmark.

Again, all that’s happened here is cutting the stock index allocation and shifting into 100% short term treasuries when the economic regime suggests that conditions are not favourable to stocks. This makes intuitive sense. It is contingent however on having an accurate gauge of the economic regime.


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1 low cost S&P 500 Index ETF
2 low cost short-term treasuries ETF
3 Declining Growth, Rising Inflation