Warren Buffett’s Two-Fund Portfolio: It’s Easy

Warren Buffett’s Two-Fund Portfolio

Most people should follow the keep it simple, stupid, or KISS principle for retirement plans because the complexity will probably result in poor long-term returns. This strategy requires workers to keep costs low, use passive index funds, and maximize contributions. An investor can pick a pre-defined asset allocation, like Warren Buffett’s Two-Fund Portfolio.

At this point, it makes sense to quote John Bogle, who has probably done more to ensure decent retirements than anyone else. He stated,

 “Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.”

The first two criteria we outline are easy, and the third one is harder, depending on your weekly expenses and budget. Today, an investor can easily find inexpensive index funds. However, maximizing contributions may be challenging at first. But as your income grows, it is only a matter of time before you attain the maximum contribution level. The reason for following the above three criteria for retirement portfolios is simple. They work overtime.

Buffett on Retirement Portfolios

What does Warren Buffett say about retirement portfolios? He has discussed it in the context of staying inside a “circle of competence.” He believes most investors have not studied businesses and thus should avoid stock picking. Hence, in his 2013 annual letter, Buffett states,

“The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

Moreover, Buffett expounds on his wisdom,

“Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long- term results than the knowledgeable professional who is blind to even a single weakness.”

But where does the idea of a two-fund portfolio originate? We must further read Buffett’s 2013 annual letter to find out. Below is a quote from his 2013 annual letter where Warren Buffett talks about his two-fund portfolio. He said,

“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) 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.) 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.”

A Simple Two-Fund Asset Allocation

Warren Buffett’s two-fund portfolio comes down to a straightforward 90:10 asset allocation of an S&P 500 Index fund and United States Treasury short-term government bonds. The S&P 500 Index fund is self-explanatory because many workers have this choice in their 401(k) plans. Short-term government bonds are 1-to-3-year U.S. Treasury bonds. They are attractive because some investors view them as low risk. 

Notably, this two-fund portfolio does not include an international stock or bond fund. However, this fact is unsurprising since Warren Buffett focuses on the American economy. Furthermore, most of the stocks in the S&P 500 Index have relatively large international sales providing exposure to global economies.

In addition, the two-fund portfolio lacks exposure to REITs, gold, intermediate and long-term bonds, and alternative asset classes. It is probably the most straightforward retirement portfolio one can achieve. However, this portfolio is concentrated in large-cap U.S. equities. Hence, it may be perceived as risky and not diversified. 

From Buffett’s perspective, short-term bonds are a place to park cash. In addition, they are usually a haven during times of economic duress or market corrections. But 10% in short-term bonds is only a little diversification. However, a back test study illustrates that it merely has a 2.3% failure rate in a 30-year retirement window using the 4% withdrawal rule. So Warren Buffett’s two-fund portfolio may not be as risky as perceived.

Implementation

The Warren Buffett two-fund portfolio is easily implemented using index funds or ETFs from Vanguard. Alternatively, comparable funds from BlackRock, Schwab, or Fidelity can be used. The table below lists the index and exchange-traded funds with their expense ratios.  The stocks funds are the Vanguard 500 Index Investor (VFINX) or the Vanguard S&P 500 ETF (VOO). The short-term Treasury funds are Vanguard Short-Term Treasury Index Fund (VSBIX) or the Vanguard Short-Term Treasury ETF (VGSH).

Asset Class	Vanguard Index Fund	Expense Ratio	Vanguard ETF	Expense Ratio
S&P 500 Index	VFINX	0.14%	VOO	0.03%
U.S. Short-Term Treasuries Index	VSBSX	0.07%	VGSH	0.04%

An investor using Admiral shares will have a lower expense ratio than investor shares. 

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Performance and Risk

We conduct an evaluation using Vanguard funds to assess further the performance and volatility of Warren Buffett’s two-fund portfolio.

Using the Portfolio Visualizer tool, we assess the two-fund portfolio from January 2010 to December 2022. In this comparison, we compare the Vanguard 500 Index Investor (VFINX) and Vanguard Short-Term Treasury Index Fund (VSBIX) in a 90%/10% ratio as portfolio 1, 100% VFINX in portfolio 2, and Vanguard Total Stock Market Index (VITSX) and Vanguard Total Bond Market Index (VBFMX) in a 60%/40% ratio in portfolio 3.

We assume the portfolios are rebalanced annually. Also, we focus on the compound annual growth rate (CAGR), standard deviation, and max drawdown numbers.

Clearly, portfolio 2 (100% S&P 500 Index) is the most volatile, has the most significant max drawdown, and has the best and worst years by a decent margin. However, the improvement in CAGR is only about 1.0% better than portfolio 1 (90%/10%). The benefit of adding 10% short-term U.S. Treasuries is lower volatility and max drawdown at only a minimal cost for CAGR.

The growth of portfolio 2 is more significant than portfolio 1 or 3. However, investors must remember the decade-long bull market in tech stocks fueled a rise in S&P 500 Index. If the funds had longer histories, the backtest would show less difference in the annualized returns and portfolio growth.

The max drawdowns are worse for Portfolio 2 because the portfolio is 100% stocks. Furthermore, the drawdowns were longer on average for Portfolio 2 that the other two asset allocations. Portfolio 1’s drawdowns are slightly better, but only by a little. However, the 60%/40% portfolio 3 has much more tolerable drawdowns of shorter duration. In addition, the volatility is less but at the expense of lower annualized returns.

Final Thoughts About Warren Buffett’s Two-Fund Portfolio

Most retirement plans have an S&P 500 Index fund and a short-term U.S. Treasury bond option. Hence, Warren Buffett’s Two-Fund Portfolio is easy to apply. The pros of this portfolio are simplicity, ease of realization, low cost, and capturing much of the S&P 500 Index’s returns with slightly lower volatility. In addition, Warren Buffett recommended it. The cons are concentration, lack of diversification, too much exposure to large-cap stocks, no exposure to small-cap and mid-cap or international stocks, volatility, and more significant max drawdowns. That said, the S&P 500 Index has provided good returns over time, and adding a short-term U.S. Treasury bond fund seems like a good idea.

However, like some of the other lazy portfolios I have discussed, the 60% total stock market and 40% total bond portfolio is always a good alternative.

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