Much of the investing and financial advice landscape is complex, and often unnecessarily so. For most people who are saving for retirement, a portfolio that holds a combination of stocks and bonds will be the best path for achieving their goals. This simple approach can get complicated quickly, however, with advisors recommending different funds and changing asset allocations based on market predictions.
The idea of a three-fund portfolio appeals to many investors because it simplifies the investment process by focusing on the key asset classes you need exposure to and minimizing the fees you pay along the way. Here’s more on the three-fund portfolio and how you can build one for yourself.
What is a 3-fund portfolio?
A three-fund portfolio is an investment strategy that involves holding mutual funds or ETFs that invest in U.S. stocks, international stocks and bonds. The strategy is popular with followers of the late Vanguard founder John Bogle, who valued simplicity in investing and keeping investment costs low.
The strategy focuses on gaining broad exposure to key asset classes by holding low-cost index funds. Investors following this strategy will look for total-market index funds that track an entire market such as U.S. or international stocks. The resulting portfolio typically offers good long-term growth prospects, diversification benefits and some current income from the bond allocation.
The three funds can be held in different amounts based on the investor’s risk tolerance and how close they are to meeting their goals. If the funds are held in equal one-third weights, it would translate to a portfolio that is made up of two-thirds stocks and one-third bonds.
How to build a 3-fund portfolio
A three-fund portfolio consists of a U.S. total market stock fund, an international total market stock fund and a total market bond fund. These funds can be purchased through online brokers, and you typically shouldn’t have to pay an expense ratio of more than 0.10 percent.
Once you’ve identified the funds you’d like to purchase, you’ll need to determine how much to invest in each fund. In general, investors who still have decades before they plan to retire will hold a greater portion of stocks compared to bonds, while those who are close to retirement or already retired will have more invested in bonds.
One simple formula to determine the percentage of your portfolio to hold in stocks is to subtract your age from 100 (100 – age = amount in stocks). However, some experts think this approach is overly conservative.
Pros and cons of a 3-fund portfolio
Pros
- Simplicity: One of the main attractions of the three-fund portfolio is its simplicity. You’re essentially owning the entire stock market and bond market, so you don’t have to worry about whether now is the time to buy small-cap growth stocks or if you should take a chance on high-yield bonds. It’s just three funds and that’s all you have to keep track of.
- Diversification: By holding total-market index funds that track stocks and bonds, you’re choosing to hold a diversified portfolio. This means that your fortunes aren’t tied to any one security and you will receive the total market return from stocks and bonds.
- Low costs: Total-market index funds can be purchased for low costs, typically less than 0.10 percent annually and often even cheaper. Keeping expenses low is one of the best ways for investors to make sure that more of the investment return ends up in their pocket.
Cons
- Requires monitoring:One downside of the three-fund portfolio is that it will require monitoring and rebalancing from time to time. You won’t just be able to set it and forget it. You’ll probably want to rebalance the portfolio to make sure it’s inline with your desired allocation at least on a quarterly basis.
- Could miss out on higher returns: By deciding to hold a diversified portfolio of index funds, you’re also agreeing to miss out on the higher returns that can come from owning individual stocks or funds that may outperform over certain periods.
- Won’t own alternative investments: The three-fund portfolio doesn’t allow for alternative investments such as real estate or commodities, so if this is something you’re interested in you may want to have a separate allocation for alternatives.
Bottom line
The three-fund portfolio is a simple investment strategy that should meet the needs of most investors. It offers a diversified portfolio at a low cost and allows you to customize the asset allocation based on your investment goals and risk tolerance.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
FAQs
A three-fund portfolio consists of a U.S. total market stock fund, an international total market stock fund and a total market bond fund. These funds can be purchased through online brokers, and you typically shouldn't have to pay an expense ratio of more than 0.10 percent.
What is a 3 fund portfolio and how does it work? ›
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.
What is an investment portfolio How does it work? ›
An investment portfolio is a basket of assets that typically include stocks, bonds, cash, real estate and more. Investors generally aim for a return by diversifying these securities in a way that reflects their risk tolerance and financial goals.
What is the 3 way investment strategy? ›
With the three-fund approach, you allocate a certain percentage of your portfolio to one of three asset types: U.S. stocks, international stocks, and bonds. Older investors, including those near or in retirement, tend to prioritize capital preservation.
What is a good asset mix for retirement? ›
The moderate allocation is 35% large-cap stocks, 10% small-cap stocks, 15% international stocks, 35% bonds and 5% cash investments.
How many funds should I have in my 401k? ›
A commonly cited rule of thumb is to own between 10 and 20 mutual funds, but the actual number will vary depending on your individual circ*mstances. Too many funds can lead to unnecessary over-diversification and overlap. There's really no point in owning, say, two index funds that invest in the same index.
What are the disadvantages of a 3 fund portfolio? ›
Cons. Requires monitoring: One downside of the three-fund portfolio is that it will require monitoring and rebalancing from time to time. You won't just be able to set it and forget it. You'll probably want to rebalance the portfolio to make sure it's inline with your desired allocation at least on a quarterly basis.
How often should I rebalance my 3 fund portfolio? ›
When or how often should you rebalance your portfolio? Our research (PDF) shows that optimal rebalancing methods are neither too frequent, such as monthly or quarterly calendar-based methods, nor too infrequent, such as rebalancing only every 2 years. For many investors, implementing an annual rebalance is optimal.
What is the 70/30 ETF strategy? ›
This investment strategy seeks total return through exposure to a diversified portfolio of primarily equity, and to a lesser extent, fixed income asset classes with a target allocation of 70% equities and 30% fixed income. Target allocations can vary +/-5%.
How does Warren Buffett invest? ›
Warren Buffett's investment strategy has remained relatively consistent over the decades, centered around the principle of value investing. This approach involves finding undervalued companies with strong potential for growth and investing in them for the long term.
Many real estate investors subscribe to the “100:10:3:1 rule” (or some variation of it): An investor must look at 100 properties to find 10 potential deals that can be profitable. From these 10 potential deals an investor will submit offers on 3. Of the 3 offers submitted, 1 will be accepted.
What is the number one strategy of investing? ›
Buy-and-hold investing
The idea is to not get rattled when the market dips or drops in the short term, but to hold onto your investments and stay the course. Buy-and-hold works only if investors believe in their investment's long-term potential through those short-term declines.
How do 3x funds work? ›
In U.S. markets, most leveraged ETFs seek to produce returns of 200% or 300% compared to the returns of the underlying index or security. If the S&P 500 goes up 2% in a day, a 3x leveraged ETF tracking it will aim to return 6%. Conversely, if the S&P 500 drops 1%, the 3x leveraged ETF will have a magnified drop of 3%.
How do investors earn money from mutual funds List 3? ›
Investors in the mutual fund may make a profit in three ways: The fund may earn interest and dividend payments from its holdings. The fund may earn capital gains from selling assets held in the fund at a profit. The fund may appreciate, meaning each fund share will grow in value over time.
What is the difference between 3 fund and S&P 500? ›
A 3 fund portfolio is an asset allocation mix comprising three asset classes, domestic stocks, international stocks, and domestic bonds. Standard & Poor's 500 is a market index that tracks the market value and performance of the top 500 US large-cap stocks.
How many mutual fund portfolios should I have? ›
Creating a balanced Portfolio
As a general guideline, you can start with three to four different types of mutual funds, such as an equity fund, a debt fund, and potentially a hybrid fund or an index fund. This strategy can help you achieve diversification across asset classes and investment styles.
