The Three Fund Portfolio

[pn3069]

My 3 fund portfolio is: VG total world stock (VTWAX), VG Min Vol stock (VMVFX/VMNVX) and US Total Bond (VBTLX). I invest in the stock funds in equal amounts. I see no reason to separately hold US and xUS stock funds, and no reason to hold international bond funds.

VMNVX is weathering the current storm better than VTWAX... not sure it will do so in a continuing bear market...

 

[Animorph]

What ratio do you use for S&P 500 vs Extended Market Index?

I use 25% of portfolio each, so 50/50 for those two and a small-cap tilt.

 

[Animorph]

Beating the S&P 500 is hard when it is leading the market. Adding foreign stocks just reduces your gains. But if the S&P is not doing much it becomes easier to beat. I had my whole 401k in one foreign stock fund back in the day and it beat the crap out of the S&P 500 for quite a few years. But the U.S. stocks have been leading since then. That'll end one of these days, giving portfolio managers an easier target. Won't matter to me, my AA is set.

 

[targatom2019]

I Had over 35 stocks, sold everything last month and bought just three funds. Fido Zero total market, Fido Zero international and Fido total bond.

 

[pb4uski]

If your goal is to emulate the total market, you'd want 80% S&P 500 and 20% extended.

Vanguard's Portfolio Watch pegs it at 75/25.

 

[Suppertime]

I’ve been tracking my slice n dice portfolio against my benchmark, the Vanguard Life Strategy Moderate Growth fund which is 60/40 stocks/bonds, ~60/40 US/intl. Over the past 12 years I would have ended up with 15% more money if I’d used the Vanguard fund. If there’s a drawdown where I can sell everything without too much cap gains tax, I will put everything into a Life Strategy fund and never look back.

The automatic asset allocation and daily rebalancing is not just convenient, I’m convinced taking away tinkering will likely result in much better returns.

 

[Rdub]

I try to keep my portfolio relatively simple. However, with multiple accounts for my wife and i, and 529s for the kiddos, it gets a little more complicated. In addition to asset allocation, asset location is an important part of my portfolio. I also live in CA, so my bond portfolio consists of bond funds in our tax deferred/free accounts, CA Muni funds and a CA muni ladder in my taxable accounts in order to reach my target asset allocation. I also keep 1-2 years of cash in short term treasury ladders. The treasuries have been yielding better than CDs and they are state tax free. It gets a little complex, but I try to keep it as simple as possible.

 

[SecondCor521]

As of yesterday's close, 92.58% VTSAX, 7.42% VBTLX (current target AA is 93/7) across traditional, Roth, and taxable. So a two fund portfolio for me.

 

[pb4uski]

I try to keep my portfolio relatively simple. However, with multiple accounts for my wife and i, and 529s for the kiddos, it gets a little more complicated. In addition to asset allocation, asset location is an important part of my portfolio. I also live in CA, so my bond portfolio consists of bond funds in our tax deferred/free accounts, CA Muni funds and a CA muni ladder in my taxable accounts in order to reach my target asset allocation. I also keep 1-2 years of cash in short term treasury ladders. The treasuries have been yielding better than CDs and they are state tax free. It gets a little complex, but I try to keep it as simple as possible.

Similar story here... tax efficient placement ends up making our portfolio a bit more complicated that it would be otherwise. I know a lot of people have a high proportion of that deferred... our is only a tad over 1/2.... if we were highly tax-deferred I would go with a good balanced fund and call it a day.

 

[38Chevy454]

My feeling is that I don't want to spend all my time researching and evaluating, so the simple index funds do better than I would probably do based on minimal time investment. The three fund portfolio works well for almost all.

 

[jimnjana]

I Had over 35 stocks, sold everything last month and bought just three funds. Fido Zero total market, Fido Zero international and Fido total bond.

Still have stocks but have about 2% in the three funds you mention plus zero mid cap I think its called. Will over time grow your about 20% of the portfolio.

 

[GTFan]

Similar story here... tax efficient placement ends up making our portfolio a bit more complicated that it would be otherwise. I know a lot of people have a high proportion of that deferred... our is only a tad over 1/2.... if we were highly tax-deferred I would go with a good balanced fund and call it a day.

Same here, if you have anywhere near a 50/50 split then tax efficiency can make a nice difference. Tax-loss harvesting can be entirely optional, but it is also very useful at times. Managing income for ACA, frex.

 

[Sanbenito1]

Roth?

Where would your Roth dollars fit in this 3-fund scenario?

 

[pb4uski]

I put equities in my Roths.

 

[Doc0]

I use the "efficient frontier" calculator at portfolio visualizer. The efficient frontier is a plane of points which give risk and reward and the "risks" and "rewards" of an investment say S&P 500 is displayed and a calculation done using quadratic algebra since the risk is standard deviation which is the square root of the variance. The result is compared to a "risk free asset" which is a 3 month T Bill and the calculator draws a line called the efficient frontier. The efficient frontier therefore is a line describing the most return for the least risk.

You can next model a 2 fund say S&P and BND and generate a line which adds diversity into the equation. Diversity is provided by the correlation between 2 assets. S&P and BND have near zero correlation so when S&P goes up and down BND does not experience that gyration much. The line generated again is a line of points representing the most return for the least risk of the quadratic combination of 2 non correlated funds as a percent A A ratio. So you now can compare risk and reward for different AA and just read it off the graph.

The 3 fund adds a 3 fund analysis into the mix. Foreign is much more correlated to S&P than BND So it's addition provides way less extra diversity. Especially in the down turn the correlation between S&P and Foreign goes close to 1 so owning forefgn doesnt save you BUT foreign tends to have a higher SD so it falls farther. In 2008 S &P lost 40% some foreign lost 60-70%. This makes the 3 fund a more risky set to own than a 2 fund. If you use the calculator on a 3 fund portfolio You will NOT be on the line but to the right of the line, and portfolios right of the line contain excessive risk. You pay too much risk for your return.

Some asset combo's improve risk, sometimes REITS will improve risk/reward because for the correlation your portfolio has slightly higher return for the same risk and the resulting 3 fund is a set of AA that lives on the line. You can read the correct AA directly off the line. The calculator will allow 4 fund 5 fund 6 fund and make these calculation and allow you see where on the plane you wind up and it will draw a line of the most efficient assets of the mix. Often the most efficient includes dropping some assets and keeping others in different ratios to get the math correct. So it's a very accurate way to compare "portfolios" and understand how much risk you are paying for a given reward and if there is a combination that is more "efficient" hence the name efficient frontier.

The program also calculates the Most Efficient portfolio called the Tangent portfolio. That portfolio is the most return for the least risk and is typically pretty bond heavy for stability but a little bit of stocks for growth. I have a small TIRA I keep in the Tangent since I want steady growth with low volatility and I need a place to park my bonds anyway. Bonds are most tax efficient in a tax deferred or tax free (Roth) account. The little bit of stock allows me to re-balance in a down turn aka buy low and "sell high" as it goes up and I siphon off some of the growth and turn it into more bonds on the way up.

For me its a great way to have the best AA with the least risk. Personal Capital thinks so also since they use this kind of analysis to help set up their portfolios

 

[samclem]

For me its a great way to have the best AA with the least risk. Personal Capital thinks so also since they use this kind of analysis to help set up their portfolios

To me, trying to "fine tune" things to get the "best AA with least risk" in this manner is a bit like measuring a cube of jello with a micrometer. We don't know which AA will provide the best return or even the best risk-adjusted return next year or next decade. Will the next 10 years look like the 1970s (virtually no reward for owning stock, only greater risk?). Will it be like 2000-2009 when bond-heavy portfolios had lower volatility and higher returns than stock-heavy portfolios? We have to admit that we don't know.

So, I think it makes a lot of sense to look at a longer period (the black line above) to pick an allocation and realize (looking at all th decades in the chart above) that given the great likely variance from year to year and decade to decade, there is not much point in obsessing over the "best" allocation. That will be evident only in retrospect.

And, more fundamentally, the idea of using volatility as a stand-in for "risk" is highly flawed, IMO. It is very easy to build a fixed income portfolio with very low volatility ("low risk") that is at tremendous risk from future inflation.

 

[Doc0]

So, I think it makes a lot of sense to look at a longer period (the black line above) to pick an allocation and realize (looking at all th decades in the chart above) that given the great likely variance from year to year and decade to decade, there is not much point in obsessing over the "best" allocation. That will be evident only in retrospect.

And, more fundamentally, the idea of using volatility as a stand-in for "risk" is highly flawed, IMO. It is very easy to build a fixed income portfolio with very low volatility ("low risk") that is at tremendous risk from future inflation.

No question this is a statistical technique. We live statistical lives. You may find this flawed but Harry Markowitz at Chicago won the Nobel for his work on Modern Portfolio theory using this technique. In your world the path into the future has only one unknowable path. In my world the path into the "futures" exists in a statistically normalized bell curve with the mean as the most likely future and less statistically probable futures well represented as well. The tool to analyze that is not the efficient frontier but the Monte Carlo tool. Efficient frontier is for efficient asset allocation, Monte Carlo is for portfolio projection and likelihood of success. Personal Capital uses Monte Carlo to predict your portfolio's success at the 50% level and 10% level of certainty so it's a well used quantitative technique as well used in the financial world.

I would as you what number you use to assign risk if not variance or the square root of variance?

 

[mmgoebe]

3 Funds - need Dividends !

I am confused. We are retired. The Growth Years are over. Time to gather tax efficient dividends from quality stocks to spend, or gift down the line. If the markets retreat, the cash flow still comes. It works - I take home, after tax, 30% more income than when I was working.

 

[target2019]

Where would your Roth dollars fit in this 3-fund scenario?

You have kinda kicked the Achilles heel of 3-fund. You mentioned one more account, but what if the retirees have more accounts (I like to call them investing spaces)?

The easy choice is to use the same three funds in all accounts.

However, at the other end of choices you can divide asset choices and split them between your 10 (in our case) investing spaces.

To answer your question, of TSM, TBM, TI, I would put BOND in Roth.

Reference
Securities in approx. order of tax-efficiency.
15 Hi-Yield bonds (least tax-efficient)
14 TIPS
13 Taxable bonds
12 REIT stocks
11 Stock trading accounts
10 Balanced funds
9 Small-Value stocks
8 Small-Cap stocks
7 Large Value stocks
6 Int'l stocks
5 Large Growth stocks
4 Most stock index funds
3 Tax-Managed funds
2 EE and I-Bonds
1 Tax-Exempt bonds (most tax-efficient)

What you do is driven by how much total $$$ in each account. If you're down the road, and not contributing new dollars there is one better choice, but if you're still contributing to Roth, something else may fit better.

When I started the Roth, I chose Vanguard REIT fund and something else. So each year my REIT exposure grew. I am definitely not using it as part of a 3-fund scenario.

What I think is true (at least true for us) is that you need at least 2-3 carefully thought-out fund choices in each account (or investing space).

 

[samclem]

I would as you what number you use to assign risk if not variance or the square root of variance?

I would offer that "risk" is a useful word with a well understood meaning. Using the word "risk" in lieu of the term "square toot of variance" muddles the issue, it doesn't clarify it.

A retiree can, today, purchase a portfolio 100% of 30 year Treasuries with a fixed yield of 2.6%. He may be told by his FA that his portfolio is risk free, since it has no repayment risk and zero variance in rate of return (heck, if the rate were -10%, it would still be risk free). Now, in the way most people understand the word "risk" in their daily lives, is the real (i.e. inflation-adjusted) value of our retiree's portfolio truly at zero risk over the next 3 decades? Is its real return free of variability, variance, and fluctuation?

Using correct term ("square root of variance in annual return") improves the situation, IMO.

 

[mountainsoft]

I like the simplicity of a single fund. I personally use the Vanguard Balanced Index Fund (VBIAX) with a 60/40 mix in my Roth and Traditional IRA's. For my taxable account I use Vanguard's Tax Managed Fund (VTMFX) with a 50/50 mix. Both have very similar performance.

I compared the Bogleheads 3-fund portfolio against VBIAX a while back and didn't see much difference in performance at the cost of more complication.

If I wanted to reduce my risk, I would probably opt for one of Vanguards Life Strategy Funds, such as VASIX with a 20/80 mix, or VSCGX with a 40/60 mix.

https://investor.vanguard.com/mutual-funds/lifestrategy/#/mini/overview/0723

 

[2177V]

Aside from this forum, my favorite financial forum is the Bogleheads Forum. Like this one, it includes many really smart people who simply want to help and tolerate basic newbie questions that may seem stupid to those in the know. Nothing ticks me off more than when I ask a question on a forum and somebody replies with "Why not just Google it?". They don't seem to understand I DID Google it and I don't understand what I read. Anyway, that being said, one of the basic tenants of Bogle Investing is the index fund approach to investing. Similar to what Ben Stein recommended in his book. Your total portfolioi is three index funds, total domestic stock, totoal international stock, and total bond market. I think this was originally called the Couch Potato portfolio. Jack Bogle in a 2017 interview said he does not include International in his portfolio, but he can see the logic of doing so. This simple approach makes a lot of sense to me. Does anyone have any feelings yay or nay on this investing approach? I should add, I am a p poor investor, am not interested in finance or investing, am just looking for a reasonably safe way to park my IRA money in retirement that requires little or no maintenance.

My comment:
I have no problem with the total domestic stock and total international stock. I do have an issue with the total bond market based on the following link:

https://obliviousinvestor.com/what-happens-to-bonds-in-a-stock-market-crash/

During the 2008 crash, stock declined -50%, high yield corp bond declined -30%, intermediate investment bond -10%, government bonds gained +12%.

Point #1: Bonds behave differently during a crash.
Point #2: Total Bond funds co-mingle government bonds for safety with long term bonds for performance. Therefore the gain or loss of a total bond fund is a composite of the bond portfolio.

I personally have separate bond funds of government or short term corporate bonds for safety (but lower performance) and long term bonds for performance (but higher risk during a crash). Since i allocate the amount, I can control the risk and performance better than a total bond fund.

During a crash, your stock funds loses liquidity because you should not cash in your stock fund after it decline 50%. Therefore you are more dependent on your bond fund. My question to investors: Do you have a rainy day fund to withdraw during your retirement in the event of a crash? If not, do you feel "safe" hoping your total bond fund does not decline in value after a crash?

I personally do not. This explains why I decided to separate my bond funds into a "safety" category and into a "performance" category.

If you are not in retirement or are not close to retirement, then you can only have one total bond fund because liquidity is not important because your paycheck provides liquidity. However, when you start to come close to retirement or are in retirement, you should think about "liquidity" since your pay checks are about to end.

 

[OldShooter]

If you want market average returns, this is the portfolio for you. It's not for me. ...

This statement and similar ones are common in writings by people who are advocating stock-picking. IMO they have a sort of sneering quality.

As a passive investor over the long term, literally a half-century* of data predict that I will beat around 95% of stock-picking mutual fund "expert investors."

So what I want is exceptional returns compared to my alternatives, and passive investing is the only strategy that has consistently been shown to delivered them.

--------------------------------------

*The earliest data I know of is Michael Jensen's PhD thesis published in 1967. (https://papers.ssrn.co/sol3/papers.cfm?abstract_id=244153) He studied the 20-year record of 115 mutual funds, an awesome accomplishment considering the limited computer power and lack of easily accessible data when he was working. From the abstract:

"The evidence on mutual fund performance indicates not only that these 115 mutual funds were on average not able to predict security prices well enough to outperform a buy-the-market-and-hold policy, but also that there is very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance. It is also important to note that these conclusions hold even when we measure the fund returns gross of management expenses ... Thus on average the funds apparently were not quite successful enough in their trading activities to recoup even their brokerage expenses."
​

In the last couple of decades, S&P's SPIVA report cards have made this pretty well settled science, despite the deafening and ongoing protests of those whose paychecks depend on investors not realizing this. As Upton Sinclair observed 85 years ago: “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

 

[OldShooter]

No question this is a statistical technique. We live statistical lives. You may find this flawed but Harry Markowitz at Chicago won the Nobel for his work on Modern Portfolio theory using this technique. In your world the path into the future has only one unknowable path. In my world the path into the "futures" exists in a statistically normalized bell curve with the mean as the most likely future and less statistically probable futures well represented as well. ...

IMO there are a couple of detail problems with MPT. First, variance is not identical to risk. For someone who is forced to sell, it may be but there is also risk like Enron, Sears Holdings, Montgomery Ward, JDS Uniphase, and (lately) GE. The other problem is that the distribution of stock prices is far from being a classical Gaussian bell curve. A Gaussian is symmetrical, centered on zero, and standard deviation is predictive. The market distribution is not centered on zero, it is not symmetric, and most importantly it has fat tails with most of the fat on the left (downward) side. In his latest book, Markowitz still argues that a Gaussian is an adequate approximation and maybe for his purposes it is. But things like the tech bubble and the housing crash are clearly far outside any Gaussian prediction and those who do not understand this are building houses on sand.

I have read that, postwar, economists were trying to make their work more mathematical in order to differentiate themselves from the soft sciences like psychology and sociology. By equating risk, which is hard to measure, with variance, which is easy to measure, and by postulating the Gaussian curve, Markowitz could play with mathematics to his heart's content. IMO his other insights, like pointing out the effects of asset correlations, are far more important.

 

[2177V]

If you want market average returns, this is the portfolio for you. It's not for me.

Then the three fund portfolio would be good for you.

I agree with these comments since everyone have different investment style. To impose one investment style onto another may not be appropriate.

I am not going into the debate of "buy and hold passive investing" versus "buy low and sell high active investing".

My personal investment style is a hybrid of sort. I maintain a 50%/50% portfolio but when there is a market decline of 10% or more, I re-allocate to 60% stock/40% bond in order to make money on the recovery. This means I sell and risk only 10% of my portfolio in order to buy more stock using my bonds in my IRA. I am similar to my wife...who can't resist a sale.

After the market has recovered, I re-allocate back to 50%/50%. As a result, my return on my portfoiio is above average compared if I did nothing. I should only lose money if the market never recovers. Note that 90% of my portfolio remains the same as a buy and hold passive investor.

I generally made a little bit more money using this method over the last 40 years but this takes experience and courage to re-allocate your portfolio after a market decline. This method is not for everybody. Most passive investors do not have the nerve or experience to do this.