But what if you want a simple, diversified portfolio that doesn’t require a lot of time or effort? A three-fund portfolio may be the right solution for you.
In this article, we’ll discuss what a three-fund portfolio is and how to build one yourself very easily. We’ll also look at some of the benefits of using this type of investment strategy. So if you’re ready to get started, keep reading!
What Is a 3-Fund Portfolio?
A three-fund portfolio (also known as the “lazy portfolio”) is a simple investment strategy that involves investing in just three different asset classes:
- A domestic (U.S.) stock index fund
- An international stock index fund
- A bond index fund
By investing in these three asset classes, the investor can achieve a well-diversified portfolio with very little effort. And because you’re investing in index funds, you’ll also be getting exposure to a large number of individual stocks and bonds (which is important for diversification purposes). For example, a total stock market fund attempts to reflect the performance of the market as a whole, so it’s not dominated by just a few large companies.
The purpose of the domestic and international stock funds is to fuel long-term growth, as stocks typically achieve solid growth over long periods of time. The bond fund is added to the mix to provide stability and help protect against losses in the stock market.
Typically, bonds are more stable than stocks in a bear market, so the three-fund portfolio provides adequate growth potential while attempting to cut back on the wild swings experienced by the stock market.
One of the reasons why people choose the three-fund portfolio approach is because it doesn’t require adjustments based on whether the stock market is up or down. The idea is to use this approach and allocation consistently over the long term.
The Benefits of the 3-Fund Portfolio
There are a few specific reasons why many investors like this approach.
Simple and Clear
The three-fund portfolio is very easy to understand and implement. You’re simply investing in three different asset classes and letting the market do its thing over time.
This approach doesn’t require any complicated analysis or guessing about what stocks or sectors will perform well in the future. You certainly don’t need to be a financial expert to implement the strategy for retirement planning.
It’s suitable whether you’re a beginner or an experienced investor.
By investing in a domestic stock index fund, an international stock index fund, and a bond index fund, you’re automatically diversifying your investment portfolio across many different asset classes, geographies, and industries. This helps to protect you from losses if any one particular asset class or region experiences a downturn.
Most stock index funds hold hundreds of individual stocks, so you’re also getting diversification within each asset class. It’s tough to beat this type of diversification while only investing in three simple funds.
(Relatively) Low Risk
While there’s always risk involved with investing, the three-fund portfolio approach can help to minimize it for long-term investors. By investing in a bond index fund, you’re automatically adding some stability and protection against losses if the stock market declines.
Of course, no investment is ever completely risk-free. However, the three-fund portfolio provides a good balance of growth potential and stability.
Another advantage of the three-fund portfolio is that it’s very low cost. All you need to do is buy three mutual funds, and you’re good to go. You don’t need to hire a financial professional to manage your portfolio for you. There are no management fees or other hidden costs associated with this type of investment strategy.
And because you’re investing in low-cost index funds, the expense ratios (the amount you pay in annual fees) are very low as well. This helps to keep more of your money working for you instead of being eroded away by high fees.
The three-fund approach also provides you with a level of flexibility. If you prefer, you can adjust the allocation over time to suit your preferences. For example, if you’re young and primarily saving for retirement, you may choose to have a higher percentage of your money in the stock market mutual funds and a lower percentage in the bond fund. As you get older and closer to retirement, you may prefer to take a more conservative approach by increasing the allocation of the bond fund.
This is just one example, but you can adjust the allocation and even the specific funds in your portfolio if you prefer.
Disadvantages of the 3-Fund Portfolio
Of course, there are also a few disadvantages to the three-fund portfolio that should be considered.
Requires You to Look After the Portfolio
If you’re going to implement the three-fund portfolio approach, it’s important to understand that you’ll need to keep an eye on your investments and make sure they’re still in line with your goals. This may require some work on your part, as you’ll need to rebalance the portfolio from time to time.
For example, if the stock market has a strong year and your stock index funds outperform the bond fund, you may want to sell some of your stocks and buy more bonds to maintain your desired asset allocation.
This isn’t a huge disadvantage, but it’s something to be aware of before implementing this investment strategy.
You May Miss Out on Some Asset Classes
While the three-fund portfolio provides diversification across many different asset classes, there are still some asset classes that are not represented. For example, you won’t find any real estate, commodities, or alternative investments in a three-fund portfolio.
If you’re looking for even more diversification, you may need to add additional funds to your portfolio. However, this goes against the simplicity of the three-fund approach.
May Not Produce Maximum Returns
Another potential disadvantage of the three-fund portfolio is that you may not achieve the highest possible returns. This is because you’re investing in index funds, which track the market averages.
While this does provide diversification and stability, you won’t be able to outperform the market if you invest in a three-fund portfolio. If you’re looking to beat the market (which is very difficult to do), this isn’t the right investment strategy for you.
How to Build a 3-Fund Portfolio
If you’ve decided that the three-fund portfolio is a good fit for you, here are the simple steps you should follow.
This article is for informational purposes only and should not be interpreted as financial advice. If you need personalized advice based on your own situation, please reach out to a financial professional.
Step 1: Determine Your Asset Allocation
The first step is to decide how you want to allocate your assets between U.S. stocks, international stocks, and bonds.
If you’re in your 20s or 30s, you may prefer to have a smaller amount in bonds, which would give you a better chance to maximize long-term gains. For example, you might choose to hold only 20% or 25% in bonds.
Many people who use the three-fund portfolio approach prefer to allocate a higher percentage to U.S. stocks and a lower percentage to international stocks.
An example allocation may be:
- 60% U.S. stocks
- 20% international stocks
- 20% bonds
What’s right for you will depend on your own situation and preferences, so take the time to evaluate the options.
Step 2: Choose Your Funds
Now it’s time to select the specific funds you want to use for your three-fund portfolio. For each asset class, there are many different options available. Vanguard mutual funds are very popular for the three-fund portfolio, but they’re far from the only option. You may have a preference for one of the options below, but the differences between them are minimal.
Vanguard 3-Fund Portfolio
- U.S. Stocks: Vanguard Total Stock Market Index Fund (VTSAX)
- International Stocks: Vanguard Total International Stock Index Fund (VTIAX)
- Bonds: Vanguard Total Bond Market Fund (VBTLX)
Fidelity 3-Fund Portfolio
- U.S. Stocks: Fidelity ZERO Total Market Index Fund (FZROX)
- International Stocks: Fidelity ZERO International Index Fund (FZILX)
- Bonds: Fidelity U.S. Bond Index Fund (FXNAX)
Schwab 3-Fund Portfolio
- U.S. Stocks: Schwab Total Stock Market Index (SWTSX)
- International Stocks: Schwab International Index (SWISX)
- Bonds: Schwab U.S. Aggregate Bond Index Fund (SWAGX)
Of course, these are just some of the possibilities. There are many other suitable funds you could use if you prefer.
Step 3: Invest
Once you’ve chosen your funds, it’s time to start investing. You can do this by opening an account with the brokerage of your choice and transferring money into the account.
Of course, you’ll be investing whatever money you have right now, but it’s also important to keep adding to it.
Many brokerages offer automated investing services, which make it easy to set up a regular investment schedule. For example, you could choose to invest $500 per month into your three-fund portfolio.
Step 4: Rebalance Periodically
Once you’ve started investing, it’s important to periodically rebalance your portfolio. This simply means adjusting the percentage of each asset class in your portfolio to match your original allocation.
For example, if you originally allocated 60% for a U.S. stocks mutual fund, 20% for international stocks, and 20% for bonds, but the value of your U.S. stocks has increased so that they now make up 70% of your portfolio, you would need to sell some of your U.S. stock holdings and invest the proceeds into international stocks and bonds.
How often you should rebalance depends on how close you want to stick to your original asset allocation. Some people rebalance once per year while others do it more frequently.
Alternatives to the 3-Fund Portfolio
While the three-fund portfolio is an excellent option, there are other possibilities that you may want to consider as well.
Target-date funds are mutual funds that automatically rebalance and adjust their asset allocation over time.
For example, a target-date fund for someone retiring in 2030 would have a different asset allocation than a target-date fund for someone retiring in 2050.
The biggest advantage of target-date funds is that they’re simple to set up and manage. You don’t need to worry about rebalancing or making any changes to your portfolio; the fund will do it all for you.
The downside of target-date funds is that you don’t have the same level of control as you would have with the three-fund approach. Additionally, the expense ratios of target-date funds tend to be a little higher, so you’ll pay more in fees.
Another option is to invest in a single fund that tracks a broad market index, such as the S&P 500.
This approach is even simpler than using a target-date fund because you only need to choose one fund and you don’t need to rebalance. However, it’s also riskier because you’re putting all of your eggs in one basket.
If you want a little more diversification than what you would get from a single-fund portfolio, you could invest in two funds: one that tracks the U.S. stock market and a bond fund.
This approach is similar to the three-fund portfolio, but with only two asset classes instead of three (by eliminating international stocks).
Another alternative is to use a global stock market index fund instead of a U.S. stock market fund, which provides exposure to international companies.
The four-fund portfolio is the same as the three-fund portfolio, except it adds an international bond fund for greater diversification. Another option is to add a real estate fund for the fourth spot.
Frequently Asked Questions
There’s no one-size-fits-all answer to this question because it depends on the individual circumstances of the investor, such as age, investment goals, and risk tolerance.
There’s no perfect model portfolio because it depends the circumstances of the investor, but a good starting point is to allocate 60% to U.S. stocks, 20% to international stocks, and 20% to bonds. You may prefer to adjust that based on your goals, your age, and your level of risk tolerance.
The main difference is that a target-date fund automatically rebalances and adjusts its asset allocation over time. With the three-fund approach, you’ll need to manually rebalance your portfolio to keep it on track.
There’s no exact answer, but a good rule of thumb is to rebalance once per year or when your asset allocation gets too far out of balance.
It depends on the specific asset allocation that you choose. However, you can see detailed results of the popular Bogleheads three-fund portfolio for an example.
The first step is to choose the specific index funds you want to use. Then, you’ll need to decide how much to allocate to each one. Once you have your asset allocation set up, you can begin investing.
The three-fund approach is often recommended as a simple and effective way to diversify your portfolio. However, it may or may not be right for you depending on your situation and your financial goals.
This depends on your age, your investment goals, and your risk tolerance. A good starting point is to allocate 20% of your portfolio to bonds. You may prefer a smaller allocation if you’re younger or a larger allocation if you’re older.
No, you can open an account with any broker that offers Vanguard funds. However, be sure that you’re not paying additional fees to access these funds through your broker or choice.
Final Thoughts on the 3-Fund Portfolio
The three-fund portfolio is an excellent way to build a simple, diversified investment portfolio. It’s easy to set up and manage, and it provides exposure to a variety of asset classes.