You might have noticed that I don’t usually list my exact stock market investments. I usually say something general like “I invest in index funds.”
That’s mostly because I don’t claim to be an investing expert and don’t want someone to mindlessly copy what I do. Simply repeating my actions without considering the many issues related to a person’s specific circ*mstances may or may not work out.
That said, I do get questions now and then about what I’ve invested in, so I thought I’d address that today.
As I share my background, one caveat is that my investments have not been as noted below since day one. It took me a some time and many mistakes to finally come upon a plan I wanted to commit to.
I had to go through the I-know-better-than-everyone-else phase where I picked individual stocks. I followed that up with the mutual-funds-are-better-so-why-not-invest-in-30-of-them phase. It was an administrative mess.
That said, I was roughly in the investments noted below for 15 years or so. There were my primary growth investments which drove my investing results for so long.
Eventually I expanded my investments to include real estate,dividend stocks, private loans, etc. but for the bulk of my investing history the only thing I held is what’s detailed below.
If I had to do it all over, I would have diversified earlier, but it all worked out and that’s for another post anyway. Today, I just wanted to share the specifics of what I’ve meant when I say I invest in “index funds.”
The Three-Fund Portfolio
Once I worked through all my investing issues, I hit upon a concept that was both simple and effective.
It’s called the three-fund portfolio and the best I can tell the concept was born somewhere in the late 90’s.
What is the three-fund portfolio? Let’s review some sources for a few definitions…
The book The Bogleheads’ Guide to the Three-Fund Portfolio: How a Simple Portfolio of Three Total Market Index Funds Outperforms Most Investors with Less Risk
gives a high-level overview from the preface as follows:
I often am asked, “What’s so special about the Three-Fund Portfolio?”
The answer is simple: By owning just three low-cost total market index funds (Total U.S. Equity, Total U.S. Bond, and Total International Equity), investors have historically outperformed the vast majority of mutual funds over time.
Sounds pretty sweet, right?
For a slightly different take, The Bogleheads forum defines it as follows:
A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock “total market” index fund, an international stock “total market” index fund and a bond “total market” index fund. It is often recommended for and by Bogleheads attracted by “the majesty of simplicity” (Bogle’s phrase), and for those who want finer control and better tax-efficiency than they would get in an all-in-one fund like a target retirement fund.
There is no magic in the number three; the phrase is shorthand for a style of portfolio construction that emphasizes simplicity, and is related to lazy portfolios.
Forbes defines it as follows:
A 3-Fund Portfolio is simply an investment portfolio comprised of only three assets, which are typically low-cost index funds. It is a type of lazy portfolio since it requires very little maintenance on your part.
This means that you can spend less than a couple of hours annually to monitor and adjust your portfolio. That’s a small inconvenience for avoiding the cost of having someone else manage your portfolio for you.
Since we’ve heard the term “lazy portfolio” a couple times already, let’s review what that is for a moment.
Here’s how The Balance defines it:
A lazy portfolio is a collection of investments that require very little maintenance. It is considered a passive investing strategy, which makes lazy portfolios best suited for long-term investors with time horizons of more than 10 years. Lazy portfolios can be considered an aspect of a buy and hold investing strategy, which works well for most investors because it reduces the chances of making poor decisions based upon self-defeating emotions, such as fear, greed, and complacency, in response to unexpected, short-term market fluctuations.
Therefore being lazy is a good thing when it comes to investing! The best lazy portfolios can achieve above-average returns while taking a below-average risk because of some key features of this simple, “set it and forget it” strategy.
And another take from the Bogleheads:
Lazy portfolios are designed to perform well in most market conditions. Most contain a small number of low-cost funds that are easy to rebalance. They are “lazy” in that the investor can maintain the same asset allocation for an extended period of time, as they generally contain 30-40% bonds, suitable for most pre-retirement investors.
In short, a three-fund portfolio is a lazy portfolio that contains three low cost index funds.
The Advantages of Three-Fund Portfolios
So why would you want a three-fund portfolio?
According to The Bogleheads’ Guide to the Three-Fund Portfolio here are the benefits of this strategy:
- No advisor risk
- No asset bloat
- No index front running
- No fund manager risk
- No individual stock risk
- No overlap
- No sector risk
- No style drift
- Low tracking error
- Above-average return
- Simplified contributions and withdrawals
- The benefit of consistency
- Low turnover
- Low costs
- Maximum diversification (lower risk)
- Portfolio efficiency (best risk/return ratio)
- Low maintenance
- Easy to rebalance
- Tax efficiency
- Simplicity (for investors, caregivers, and heirs)
If you want to dig deeper into what each of these mean, check out the book. It’s a very easy read — about 80 pages in total.
The Bogleheads make this list a little more user-friendly with their list of benefits:
- Diversification. Over 10,000 world-wide securities.
- Contains every style and cap-size.
- Very low cost.
- Very tax-efficient.
- No manager risk.
- No style drift.
- No overlap.
- Low turnover.
- Avoids “front running.”
- Easy to rebalance.
- Never under-performs the market (less worry).
- Mathematically certain to out-perform most investors.
- Simplicity
You get the idea — you select only three funds and you get low hassle, easy management, and high returns (because of the return/cost benefits of index funds). What’s not to love?
You Must Set Your Own Asset Allocation
That said, there’s a bit more to it than that.
You still need to pick your asset allocation. You’ll decide how much goes into each fund type based on your risk profile (which will likely change over time).
The Bogleheads say, “You must decide for yourself what percentage of stocks to hold, based in part on your personal risk tolerance. There are no shortcuts and it needs to be done no matter what investment approach you are using.”
They do have suggestions though, as follows:
One traditional rough rule-of-thumb is “age in bonds,” or percentage of stocks = 100 – age. This is a conservative rule, and leads to smaller percentages of stocks than Vanguard chooses for its Target Retirement series.
The second decision is what percentage of your stock allocation should be U.S. (domestic) and what should be international. This is a much less critical decision because U.S. and international stocks have similar risk profiles and have similar long-term returns.
In 2010, Vanguard increased the international allocation of its Target Retirement and LifeStrategy funds from 20% of the stock allocation to 30%, and increased it again to 40% in 2015.
If you want a bit more guidance, Vanguard actually has an asset allocation tool to help you decide your best mix.
A Vanguard Three-Fund Portfolio
Since I’m a Vanguard guy, my three-fund portfolio would feature Vanguard funds.
A Vanguard three-fund portfolio is generally defined as using the following funds:
- Vanguard Total Stock Market Index Fund (VTSAX)
- Vanguard Total International Stock Index Fund (VTIAX)
- Vanguard Total Bond Market Fund (VBTLX)
If you use Fidelity, Schwab, or any other of the major brokers, here’s a list of what generally comprises a three-fund portfolio with each of them.
Do You Need Both Domestic and International Funds?
Before I go further, I need to note that there’s debate on whether you need both of the first two funds or simply the first one (thus making it an even simpler two-fund portfolio).
The leading proponent of only two funds is J.L. Collins who wrote The Simple Path to Wealth
. His main reasoning is as follows:
Since almost every other allocation you come across will include an international component, why doesn’t our Simple Path? There are three reasons: Added risk, added expense, and we’ve got it covered.
He then details these as follows:
- There is unnecessary currency risk associated with owning international company stocks.
- International funds generally have higher costs. As I write this, the expense ratio for VTSAX is 0.04% while for VTIAX it is 0.11%.
- You get international exposure from owning U.S. stocks since much of the sales from U.S. companies come from international markets. Also, the thought that U.S. and international economies are fairly independent of each other is not true — there’s such a close-knit relationship that the old thought of owning international stocks because they are not correlated with U.S. stocks is hogwash.
I’ll let you decide which you prefer. I have seen intelligent people argue for both sides of the issue, so there’s no right answer in my mind.
What I’ve Done
Once I started to get my head on straight about investing and learned about the three-fund portfolio, I decided I wanted to follow that strategy with a few adjustments.
In addition, I am fairly aggressive and have a high investing risk tolerance. This may be a surprise for some since I’m generally more conservative, but for whatever reason I’m more open with index fund investing.
Given that, here’s what I did:
- I liked having both U.S. and international companies, so I opted for both.
- I was not a fan of bonds (never have been), so I had a small percent of bonds initially, then eliminated them altogether eventually. I realize this is a riskier strategy and was/am willing to live with it.
- I also liked a bit broader exposure, particularly to smaller companies with growth potential.
Given this, here’s where I’ve ended up with my investments today, which is a close proximation of what they’ve been like over the past 15 years or so:
- Vanguard Total Stock Market Index Admiral (VTSAX): 75.3%
- Vanguard Total International Stock Index Admiral (VTIAX): 14.3%
- Vanguard Small Cap Index Admiral (VSMAX): 10.4%
A few thoughts on this:
- This is my mix based on my risk tolerance and goals. This is not meant to be a suggestion of what anyone else should do.
- This mix has performed quite nicely over the past 15 years. And it’s much easier to manage than the mutual fund hodge podge I had early in my investing career (when I thought I knew it all but didn’t really know much).
- As for now, I’m letting this ride. I don’t see much that I’d want to change, though you might persuade me otherwise.
- The percentages are for my index fund investments only. In addition to these we hold real estate, invest in private loans, have a good amount of cash on hand, and own a bit of silver. We also own dividend stocks now (added recently).
Anyway, those are my thoughts on the three-fund portfolio as well as my spin on it.
Anyone else use something similar? Or perhaps you hate the three-fund portfolio. Let me know in the comments below.
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Comments
Tink saysLooks like a winning long term portfolio. Only thing I would consider is a 10% allocation in precious metals. Thanks for sharing.
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- Xrayvsn says
I too have been diminishing my bond allocation. Currently I have it at 15%. I have a reit index fund, and then domestic and international index funds as well that compose my market portfolio.
I have recently caught the gold/precious metal bug and have added that. It’s mainly gold but I do see why you opted for silver if you follow the gold silver ratio silver seems to be at a discount.
Real estate (syndications) make up the majority of my investments so I feel I have that cash flow to offset any market risk I take with lower amount of bonds
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- Timothy Tepes says
Can we talk about your Real Estate syndications…like to learn some more about them..thanks Tim
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- Xrayvsn says
Sure. I have primarily invested in 3 syndicators.
The first is 37th Parallel. I have been with them since may 2017. Although they have just recently added a fund of multi family apartments I have been in individual multifamily apartments with them (I think I am in 6 or 7 deals). Right now I have been getting from 3.5 to 6.5% distributions (some took a hit because of covid).
The 2nd is with MLG fund IV. It’s a fund of multifamily. 8% preferred rate but it is too early in this fund to have collected on that. I think right now I am in the 5-6% return.
Last is origin income plus fund. It’s an open fund (ie can buy and hold forever) that has 6% distributions that have been pretty spot on so far.
Ytd I am right at $80k for cash collected from the real estate holdings. End of October expecting a big distribution from the 37th as they send the money the month after a quarter ends (so likely another $10k or so added)
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- ESI says
FYI, we’ve been talking about these quite a bit in the Millionaire Money mentors forums and I’m looking to invest in some, so there could be some upcoming posts on them…
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- FM1 says
ESI in March of 2020 you published “How I added dividend stocks to my portfolio” two part series. Have you eliminated this part of your portfolio? Thanks for the clarification.
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- ESI says
Nope. Still have those. I edited the beginning of the post to better reflect what I was trying to say in the first place. Sorry it was confusing.
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- Anya says
This article couldn’t come at a better time. We’ve been researching index funds, stock strategies, etc and getting a bit caught up in the different options. Very helpful to see what’s been working for you.
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- MI-94 says
Agree! A good and well timed article. I also do index funds and have done so for years. At a NW of $4.5M now, so it seems to work, however I am always second guessing myself as I do consider myself a financial wizard and the index fund approach I take honesty feels too simple. It has worked well, but when I describe it to others the common reaction is a disappointed “That’s it? seems too simple”.
Another good read is the MI-146 interview. He had a very similar approach, good list of low cost funds and his allocation. I found it helpful as confirmation others were using a similar approach to mine with success. He was also a Vanguard guy.
https://esimoney.com/millionaire-interview-146/
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- MI-94 says
typo..”do NOT consider myself a wizard” oops
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- Todd says
When did you sell your dividend stocks? Didn’t you buy dividend stocks 6-7 months ago?
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- ESI says
Yes. See response to comment above. I still have them.
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- Randi Beard says
Do you have any thoughts on the passive investing bubble that Mike Green talks about? I have been listening to a few recent podcasts and just curious if you have any thoughts? Have always love this blog.
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- Jean says
What Todd says….
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- ESI says
See response to Todd…
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- Mark says
If you have been investing in this 3 fund portfolio for awhile, what has your returns have been?
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- ESI says
Whatever the funds have returned/close to market returns.
I don’t track returns precisely (like most of our millionaire interviewees) because they are the least important factor in investing performance:
https://esimoney.com/the-best-way-to-maximize-your-investment-return/
I have focused on investing as much as I can for as long as I can. As long as you do these and the returns are “decent”, you’ll do fine.
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- Peter says
My journey has been very similar … from know it all … individual stocks … mutual funds … private equity .. (high cost) private banks … and now at the near end of my investment journey … back to the simple Bogleheads philosophy.
More importantly, my experience and mistakes have not been wasted … my daughter is now starting her long term investments on the right track using the Bogleheads philosophy and the 2-3 funds (hold forever) approach.
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- ESI says
Very nice. She will do quite well with those.
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- Middle Aged Investor says
Thank you for sharing your 3 fund portfolio strategy. I am slightly older than you and my portfolio consists of 91% equities, 4.5% Bonds, and 4.5% cash. I guess I am doing the opposite of some of you in that I am increasing my weight of bonds, since I leaning towards the direction of steady and monthly income. I also have a mix a REITs in those numbers but it is currently less than 1% of the overall portfolio. With the Fed buying bonds in the open market for some time, we will only see prices increase. Allocation also should take into account any prospective appetite for volatility. Some people would rather exchange long term gains for peace of mind of steady income. Another way to also play the game is to have a separate account for the “fun money” where riskier allocations, and volatility measurement considerations are thrown out the window.
Lastly one must also consider the current tax consequences of ordinary income vs. dividends and capital gains.
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- TPM says
I have a slightly different perspective. I think doing both is warranted if you have the temperament for owning common stocks. Most people don’t or they don’t have the desire to think about investments. I agree that most people should stick with index funds or have someone else manage their money as long as they understand what they are actually invested in.
How many index holders sell out during a panic because they don’t know what is actually in the index?
If you are inclined, there is no better path to wealth than owning businesses with long tailwinds. These compounders, even if you own one or two over your investing lifetime can make meaningful impacts to your life. This is why I love individual stocks. Even if I am wrong 40% of the time, I can become wealthy.
I get your point about copying ideas. Blatantly copying is the wrong idea. However, cloning may be useful to gather great ideas into the funnel for your own due diligence. Everyone should understand why they are making any investment decision. That way they understand when they need to sell. The thing is, unknown things could happen with any business. Such is life and the nature of investing.
I am not sure why anyone would want to copy an individuals stock idea when data is readily available on the best money managers in the industry, in near real time. I know you don’t like links, but this is free and is useful https://www.dataroma.com/m/managers.php
That is part of the fun for me, understanding the probabilities, making decisions and watching the story play out. If that doesn’t sound fun to you, indexing is best.
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- ESI says
It’s not that I don’t like links. I don’t like self-promotional links or ones that have little to do with the content.
Unfortunately, I see a lot of those.
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- AB says
ESI, thanks for sharing your portfolio. For me, I prefer S&P 500 index to Total Stock because of my familiarity with the companies and similar performance. I decided not to do International for the reason you stated, exposure is already in S&P. I do not have Total Bond yet but planning to include it eventually. If I live ling enough, I will start Bond mix at 60-year old with 10% to max 50% at 70-year old. This is because I see this as long term 10+ years investment and life expectancy gets longer. Thus, right now I have one Fund portfolio in S&P 500.
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- ESI says
That’s a good option. I do like a bit more exposure to smaller companies though…
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- Wilkop says
The capitalization weighting of the major S&P 500 funds makes me a little nervous. As of 8/31/2020 just 4 stocks (AAPL, MSFT, AMZN and FB) made up about 20% of the indexes market value. While perhaps not exactly like saying 20% of my portfolio is in 4 tech stocks and the other 80 % is spread across the market, it kind of feels that way.
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- Josh M says
It’s a little surprising to see someone at your stage in life with no bonds, but based on the rest of your financials that I’ve seen, you don’t need this money any time soon, so you’re probably fine. And with rates where they are it doesn’t make a ton of sense to add them now. ESI – how do you think of think of this money? Is this money you think you’ll ever need? Or maybe will need down the road when you have less blogging (and maybe other) income?
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- ESI says
I don’t think I’ll need this money so I’m letting it grow/ride. If I live 30+ years it should be worth quite a bit by then.
I do have other funds/investments that I am using the income from to buy even more income producing assets. I’ll probably give an update on this when I do my annual financial report in February.
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- Josh M says
Thanks for the response! And this makes sense based on what I know about your finances (definitely not everything). People should remember how ESI thinks of this money before copying him. This is a good way to invest money you won’t need for 30 years (or ever).
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- RE@54 says
Wow, scary similar to us with your Index Fund journey. Stock picking, bunch of mutual funds, to a few index funds. Ha ha.
We have four index funds with Vanguard. For the international one, we use All World except US Index Admiral, VFWAX. We already have Total US, Midcap, and 500 Index.
Funny thing; 20 years ago, in my collection of funds, I had a couple of index funds. I got rid of them because “I knew” better. Ha. I wish I had kept the money in the index funds back then…
It is so much simpler this way, wish I knew this 15-20 years ago… Ha ha. It is a journey.
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- Phillip says
Sound strategy for new money/investors. I have legacy holdings in funds, sectors and individual stocks that have appreciated quite a bit. It’s not that these holding have beat the 3 fund strategy but over the years, these taxable gains will put a drag on any reallocation so I’m “stuck” near-term as the tax consequences outweigh the reallocation to a 3 fund strategy (at least while we’re still working).
There’s always a temptation to try and time or beat the market, especially when “unique” events create “great buying or selling opportunities”. To stem that temptation, I allocate around 10% of my investable assets to those “opportunities”. It’s enough money to quell temptation but not enough to get us in real trouble. It also allows you to track your performance relative to a basic 3 fund buy and hold strategy. I’ve informally tracked my own picks vs a simple buy-and-hold of index funds. It’s easy to think I’ve beat the market with my 8x gains from AAPL and overweight in the SW sector but my bets in energy and Latin America when I thought things were cheap were big busts. Overall, my results are pretty much the same as the 3 fund portfolio over a long history (which I think is pretty good).
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- Millionaire206 says
I’d love to hear more about why you (or others) prefer this approach over a Vanguard target date fund.
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- ESI says
https://www.bogleheads.org/wiki/Three-fund_portfolio
“A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock “total market” index fund, an international stock “total market” index fund and a bond “total market” index fund. It is often recommended for and by Bogleheads attracted by “the majesty of simplicity” (Bogle’s phrase), and for those who want finer control and better tax-efficiency than they would get in an all-in-one fund like a target retirement fund.”
Lots of other posts like this if you Google “why three fund portfolio over target date”.
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- Millionaire206 says
I guess I will have to read more. But my Vanguard target date fund is made up of four funds almost identical to your description, but in my case, it includes bond funds.
The only benefit I can see is potentially very slightly lower costs. Otherwise, it just seems like a bit more work/time to monitor and rebalance.
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- Chadnudj says
The simplest answer is a Target Fund will adjust its risk profile (i.e. get more conservative, with more in bonds) as you age/get closer to what they deem is retirement age, and that may not match what you want to do in terms of your portfolio’s risk or your timing for retirement.
The LifeStrategy Funds, though, are more set-it-and-forget-it type funds that stay at a given risk balance/asset allocation (LifeStrategy Growth is 80-20 stocks-bonds and includes both international stocks and international bonds) that does not really change no matter how long you hold it/how much time passes.
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- Apex says
That’s exactly right. I personally hate target date funds and would never invest in them for 2 reasons.
1. They have bonds and I wouldn’t put any money in bonds at these interest rates. I don’t see that scenario changing for quite a while.
2. They get more conservative over time which means buying even more bonds, which I definitely do not want. Some people may want that but I do not so target date funds are dead on arrival right out the gate for me.Reply
- MI-94 says
Check the performance and the expense ratios on a simple S&P 500 Index fund vs your the target date fund of your choice.
Here are 2 for example, both of which I own;
Schwab SWPPX S&P 500 Index:
10 yr return 13.66%,
Expense ratio 0.02%Fidelity FFFEX 2030 Target:
10 yr return 8.45%,
Expense ratio 0.68%Have $3M invested, that 5% delta is a lot, approximately $150k per year.
I will take the extra 5% in exchange for a little more risk and occasionally rebalancing. I don’t need the money now, nor do I expect to liquidate anytime soon, so a market downturn and added risk is not a concern.
Compared by SWPPX to ESI’s VTSAX – very close
VTSAX 10 year return 12.87%
Expense Ratio 0.04%I am a fan of the S&P Index fund, for me it has beaten most other investments I own over the long haul.
Side note: The target date fund I own only because its in an old rollover 401k that I have just left alone with the fund choices my employer offered at the time. I probably should get ride of it, but I do kind of like how in a way it is a form of diversification.
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- Chadnudj says
Alternatively, do a 1-fund portfolio using one of the Vanguard LifeStrategy Funds that matches your risk profile.
I do LifeStrategy Growth, which is 80-20 stocks with international stocks and international bonds (all using the Vanguard Total Stock/Total International/Total Bond type funds).
There’s some tax drag/slightly higher fees. But you never have to worry about rebalancing (the fund does it for you), and you could do a lot worse than just set it and forget it.
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- well wisher says
Even better than a 3 fund portfolio is Vanguard’s Target Retirement index funds. It has the us, foreign and bond funds and a bonus is it does the balancing for you.The expense ratios have come down so it’s a no brainer.
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- Diogenes says
William J. Bernstein’s advice for millennials, as of 2014:
Start by saving 15 percent of your salary at age 25 into a 401(k) plan, an IRA, or a taxable account (or all three). Put equal amounts of that 15 percent into just three different mutual funds:
• A U.S. total stock market index fund
• An international total stock market index fund
• A U.S. total bond market index fund.Over time, the three funds will grow at different rates, so once per year you’ll adjust their amounts so that they’re again equal. (That’s the fifteen minutes per year, assuming you’ve enrolled in an automatic savings plan.)
That’s it; if you can follow this simple recipe throughout your working career, you will almost certainly beat out most professional investors. More importantly, you’ll likely accumulate enough savings to retire comfortably.
If You Can: How Millennials Can Get Rich Slowly (FREE BOOK, PDF)
http://tuttle.merc.iastate.edu/Bernstein_If_You_Can.pdfReply
- ThomH says
I’ve also used a three fund process for a majority of my investing career. I love the simplicity. I have always used 120 yrs (as opposed to 100 yrs) as my starting point for diversification (ex. for a normal 55 yo, one would theoretically set his/her total equity (US & Int’l) position at 65%). However, I do have a small personal twist to my allocation theory. I am early retired, so I’m within my “sequence of return” risk window (will begin draw down at 59.5 yo), so I’ve backed off slightly, based on this added SOR risk window from 65% to a 60% equity position. In addition, I also dynamically adjust my allocation based on the market conditions (current P/E is near 30, so the market is somewhat over-heated imo), so I have backed off equity another 10% as a result, leaving me at a fairly conservative 50%/50% diversification level at this time. If the market adjusts to a normal P/E, I will add back the 10% from bonds to equity to rebalance and reflect the correction in the market. Eventually, I will increase overall equity in a Smile Glidepath fashion, once past the sequence of return risk. Just my two cents…Love the three fund theory!
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