The 3-fund portfolio

When continuing on your investing journey sometimes it can take over your life, for example having to watch tickers all day wondering when the next buy in should be. There’s other options right? I can let someone else do the watching for me and pay them a fee to manage it. Why would I pay someone when there are easier ways to do these things. A simple 3 fund portfolio can take the stress and worry out of your investing career. A 3 fund portfolio is perfect for the lazy investor, easy to set up, requires minimal effort, and can continue to run on auto-pilot as long as you need it to. Think of it like watering a plant. Now the challenge is finding the right ‘plant’ for you.

What is a 3-fund portfolio?

A 3-fund portfolio is a particular type of portfolio with 3 allocations. It’s called 3 fund because it uses 3 different index funds. The 3 types of index funds in a typical 3-fund portfolio are a total market index, international market index, and a bond market index. The total market index follows the U.S market, this includes every U.S based company imaginable. The international market index follows the international market, this includes a majority of every uprising company globally not based in the U.S. The bond market index follows the bond market, a bond is a debt security, similar to an IOU, that is issued by governments, corporations, and municipalities when they need capital. Bonds issued by the government are considered “safe” investments because they are “guaranteed” to be paid back since the government always pays back it’s debts.

Some Examples

The most popular funds are from Vanguard. Vanguard Total Stock Market Index Fund (VTSAX), Vanguard Total International Stock Index Fund (VTIAX), Vanguard Total Bond Market Fund (VBTLX). Keep in mind these aren’t the only 3 options and there are many ways to make a 3-fund portfolio.

As always index funds have a high buy in and don’t work the way stocks do. You can always substitute index funds for their ETF counterparts. ex (VTSAX) –> (VTI). That way you can purchase them on your brokerage like you would any other stock.

How does it work?

Running off the plant analogy. Once you pick your 3 plants, you’re not going to want to water them all the same. These funds all provide different amounts of gain and benefits but are there to complement each other. The international market is there as a hedge against the U.S market, or if it improves to at least have some ground in international rising markets. The bond market is there as a hedge to at least guarantee some income in retirement if else is going wrong. The Bogleheads wiki has some examples on 3 fund portfolio percentages.

For example if you’re younger you wouldn’t want to play it safe with 90% bonds because you’ll probably miss out on some gains the market will provide in the next 20 years of your life. If you’re getting ready to settle down and retire you probably wouldn’t want to be risking all your money in international markets. This is where the ‘plant picking’ comes in. You need to assess your situation and realize how risk tolerant you are.

That Simple?

Once you pick your 3 funds and allocate your percentages, you’re done. The hardest part has been completed, the foundation has been built. Now all you need to worry about is “watering” your plants. No more stock picking, no more hassle. Although you might want to reassess your situation in a couple of years and adjust your percentages since maybe you’re getting closer to retire.

Bottom Line

Building the foundation is the hard part. It’s a lot of research and getting ready to fund something big for your future. Once you pick your 3 funds and their allocations all you have to worry about is funding them. When shopping for index funds remember to keep an eye out for expense ratios since these will eat at some of your potential gains. Don’t forget about tax advantaged/deferred accounts these can save you lots of money on taxes and more potential gains for you!

Thank you for reading and see you again next Sunday,
– Pablo