If Warren Buffett weren't the world's best stock picker, how would he plan for retirement?
Luckily for the rest of us, he's answered this question before. In an annual letter to shareholders, Buffett laid out a retirement plan that would take just minutes to implement. This is the very two-pronged plan he outlined for governing the trust he's leaving behind for his wife:
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 [time stock-symbol=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.
Buffett suggests the Vanguard S&P 500 index as one of the best funds for investing in U.S. stocks. A good fund for short-term government bonds can be found under the same roof. The Vanguard Short-Term Government Bond Index Fund should fit investors just fine for this purpose.
A plan built on these two funds would be as inexpensive as it gets. Combined, a 90% mix of stocks and 10% bonds purchased through Vanguard would result in annual fees of just 0.055% of the account balance, amounting to $55 per year on a $100,000 investment, if invested in the least expensive variant of the funds. By contrast, the average fund is still 20 times more expensive than Buffett's two fund solution.
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Buffett's confidence in his 90-10 portfolio
Buffett has long been a fan of index funds, once placing a $1 million bet for charity that index funds would beat a group of hedge funds managed by sophisticated and intelligent investors. His thesis is relatively simple: The average market participant will only earn a return equal to the market average minus fees. The lower the fees, the higher the expected return.
At a 2004 annual meeting with his investors, he said, "Among the various propositions offered to you, if you invested in a very low-cost index fund -- where you don't put the money in at one time, but average in over 10 years -- you'll do better than 90% of people who start investing at the same time."
And while Buffett's portfolio may be pretty simple -- most investors hold more than only two funds -- the underlying message is important. Simplicity works. Complicating matters typically results in greater expense, and more room for second-guessing your choices.
For individuals, the most important part of the personal finance pie is not financial at all. It is behavioral. It is the ability to invest regularly, and ignore the desires to sell in fear of loss or change your buying when you fear missing out on the next bull market.
Perhaps the best anecdote of the consequences of investor behavior comes from the legendary investor Peter Lynch. As manager of the Fidelity Magellan fund, he generated average annual returns of 29% per year over his 14-year tenure. The average investor in the fund, however, managed to lose money -- selling the fund at its lows and buying high.
Therefore, the best retirement plan might just be the one so unsexy, and so uninteresting, that you can set it up and ignore it. Buffett's two-fund plan is just boring enough to work.