The most often quoted investor of our time, Warren Buffett, recently made a statement that if he pre-deceased his wife he would recommend that she put 90 percent of her inheritance in an S&P 500 index fund and 10 percent in a short term government bond index fund.

This remark caught the attention of many since Mr. Buffett has become famous for his active and concentrated investment approach which has soundly beaten the S&P 500 over the last 30 years. The idea of passively indexing an investment portfolio is not a bad one, but brings challenges for the average investor.

Index funds are low cost mutual funds and exchange traded funds (ETF’s), which allow investors to easily gain exposure to a diversified pool of stocks or bonds in one purchase. Purchasing shares of an S&P 500 Index fund gives you indirect ownership in all 500 companies in the index in the same proportion as they exist in the index. Your result will mimic that of the index with only a slight drag from the fund's operating expense ratio, which is typically quite low for these vehicles.

Mrs. Buffett will certainly inherit a lot of money from her husband who is the richest American and one of the wealthiest individuals in the world. When one has vast wealth (billions) and the stock market declines 40 or 50 percent, you still have a lot of wealth (more than a billion) to rely on for the rest of your life.

For someone with $1 million invested, the same decline turns the portfolio into about $500,000, creating a definite change in lifestyle and perhaps worries of financial survival. Techniques to reduce risk include diversification to own a broad array of investments other than stocks to reduce risk.

There is no debate that a passively managed portfolio, which always holds a targeted allocation of stocks, bonds and other vehicles, will make money over time. This is also known as a “Buy and Hold” approach. For this approach to work one very critical element must be followed – the hold.

Failing to hold when the market gets nasty and experiences dramatic declines like occurred in 1987, 2000–2003, 2008–2009, cause the investors to sell low and then be frozen in the position of being out of the market, not knowing when it is safe to get back in. So, while a passive approach is not a mistake, you should make sure that it is the right approach for you when the markets hit one of those periodic air pockets and go through a gut–wrenching decline. If you loose your nerve and bail on the plan, you are now in a very tough place.

Alternative strategies include a lot of diversification to reduce exposure to riskier assets, or some form of tactical approach to increase or decrease exposure to riskier assets in an attempt to take advantage of uptrends and avoid downtrends. There are no perfect strategies, but some have shown a high level of reliability over many market cycles. Having a plan that works for your personality and ability to assume risk is one of the most important factors in successful investing.

Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. www.breitercapital.com

Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.