A three-fund portfolio is a simple way to diversify across the world’s stock and bond markets, and ensure you hold a fair share of the full world’s market growth. It’s efficient investing with optimal simplicity.
What is a three-fund portfolio?
A three-fund portfolio consists of just three funds that make up an entire investing portfolio. They are:
- A total US stock market index fund
- A total non-US stock market index fund
- A total bond market index fund
Is there an easier way?
Yes, you may be able to buy a single target date index fund. That’s a "fund of funds" that essentially holds a three-fund portfolio inside of it. It’s the ultimate in simplicity and a single set-it-and-forget-it option that will cover you for a lifetime of investing.
Who should use a three-fund portfolio?
While simplicity has real financial value, and a target date index fund is often preferable, there are reasons to choose a three-fund portfolio:
- Target date index funds aren’t available: For example, if you live outside of the US, use a stock/ETF-focused brokerage, or are selecting funds within a 401(k), you may not have access to a target date index fund. A three-fund portfolio is an excellent alternative.
- You want to optimize tax efficiency: If you’re investing in both taxable and tax-advantaged accounts, breaking apart your target date index fund into its components allows for more tax-efficient placement. However, weigh this potential tax benefit against the added complexity it introduces.
- You want to customize: Maybe you don’t like the asset allocation glide path of a target date index fund (e.g., you want to be more aggressive for longer) or you don’t want to glide at all. A three-fund portfolio lets you pick your asset allocation yourself.
Which funds do I buy?
In general, there is no "best index fund." Any "total US stock market" index fund will perform virtually identically to all others. When crafting your three-fund portfolio, focus on funds that are available, convenient, and have low fees (avoiding transaction fees where possible).
First, decide whether to use mutual funds or ETFs. Note that both mutual funds and ETFs can be index funds. (Sometimes the term "mutual funds" is casually used to imply actively managed mutual funds, but there are also index mutual funds as shown below). Both types of index funds are generally equal in composition and contain the same stocks, although in today's world the ETF versions have a few distinct advantages.
- ETFs offer a marginal tax benefit if held in a taxable account as they never generate unexpected capital gains.
- ETFs trade free with all major US brokerages.
- ETFs transfer freely between brokerages if you decide to switch.
- ETFs trade in real-time, as opposed to once per day like mutual funds. Although this may actually be a negative if it steers you away from a long-term mentality, and tempts you into timing the market or day trading.
Once that choice is made, choose the funds that are available and low-fee from your brokerage. If you're going with mutual funds, make sure to match your funds to your brokerage to avoid fees (e.g., buy Vanguard mutual funds in a Vanguard account, Fidelity mutual funds in a Fidelity account). With ETFs, they generally trade free regardless of the brokerage (e.g. It's free to trade a Vanguard ETF like VTI in a Fidelity account). Below are some example ticker symbols.
Ticker symbols using index ETFs
Below are sample three-fund portfolios constructed using ETFs.
| Provider | Ticker Symbols (Expense Ratio) |
|---|---|
| Vanguard | 🇺🇸: VTI (0.03%) 🌏: VXUS (0.05%) 📜: BND (0.03%) |
| iShares | 🇺🇸: ITOT (0.03%) 🌏: IXUS (0.07%) 📜: AGG (0.03%) |
| Schwab | 🇺🇸: SCHB (0.03%) 🌏: SCHF (0.03%) 📜: SCHZ (0.03%) |
| Vanguard (Canada) | 🇺🇸: VUS (0.15%) 🌏: VEF (0.2%) 📜: VGAB (0.3%) |
Key: 🇺🇸: US total stock market ETF, 🌏: Non-US total stock market ETF, 📜: Total Bond ETF
Ticker symbols using index mutual funds
If your brokerage offers index funds with no transaction fees, consider the options below.
| Provider | Ticker Symbols (Expense Ratio) |
|---|---|
| Vanguard | 🇺🇸: VTSAX (0.04%) 🌏: VTIAX (0.09%) 📜: VBTLX (0.04%) |
| Fidelity | 🇺🇸: FZROX (0.0%) 🌏: FZILX (0.0%) 📜: FXNAX (0.025%) |
| Schwab | 🇺🇸: SWTSX (0.03%) 🌏: SWISX (0.06%) 📜: SWAGX (0.04%) |
Key: 🇺🇸: US total stock market index fund, 🌏: Non-US total stock market index fund, 📜: Total Bond index mutual fund
How much of each do I buy?
Choosing the proportion of each fund is called your "asset allocation." A stock-heavy portfolio is considered more aggressive, while a bond-heavy portfolio is more conservative.
Your choice depends on your age and risk tolerance. Younger investors can seek higher returns through an aggressive portfolio (e.g., 90% stocks, 10% bonds), while older investors may wish to protect their capital and generate more consistent income with a conservative portfolio (e.g., 40% stocks, 60% bonds). The asset allocation you choose ultimately depends on factors such as age, risk tolerance, and investment goals.
When choosing between US vs. Non-US, by market cap they’re about equally sized markets. Based on that, it would be fine to split US and Non-US equally. Some US investors prefer to overweight US stocks (or even eliminate the Non-US portion), based on a belief the US brand of capitalism will lead to future outperformance. Vanguard recommends allocating 40% to Non-US markets.
Ok, so how much at which age?
If we key off the Vanguard target date index funds, we get a table like this:
| Age | % US | % Non-US | % Bonds |
|---|---|---|---|
| 20 | 54% | 36% | 10% |
| 25 | 54% | 36% | 10% |
| 30 | 54% | 36% | 10% |
| 35 | 54% | 36% | 10% |
| 40 | 54% | 36% | 10% |
| 45 | 50% | 33% | 17% |
| 50 | 46% | 30% | 24% |
| 55 | 41% | 27% | 32% |
| 60 | 36% | 24% | 40% |
| 65 | 30% | 20% | 50% |
| 70 | 21% | 14% | 65% |
| 75+ | 18% | 12% | 70% |
Example asset allocations based on age
Putting it all together: A case study
This is Tiffany. 💁♀️ She wants to invest simply for her future, so she decides on a three-fund portfolio. Her brokerage account doesn’t offer mutual funds, so she decides on an ETF portfolio. She goes with Vanguard ETFs based on their great reputation for index fund investing.
She’s 35 years old and has $10,000 to invest. Based on the asset allocation tables above, she makes the following purchases:
- Buy 17 shares of VTI @ $309 per share (About $5,400, 54% of her portfolio)
- Buy 52 shares of VXUS @ $69 per share (About $3,600, 36% of her portfolio)
- Buy 13 shares of BND @ $74 per share (About $1,000, 10% of her portfolio)
Tiffany sets up auto-contributions each month in the same proportion to maintain her target asset allocation (54%/36%/10%).
When Tiffany gets a bonus, she makes larger contributions and uses a simple spreadsheet to determine how many shares of each ETF she needs to bring her three funds back to their target allocations. (This is one way to rebalance your portfolio, simply buying more of what is needed).
As she passes 40, then 45, she adjusts her auto-contributions and updates her spreadsheet to align with her new target asset allocation.
Tiffany continues to invest early and often throughout her career and never sells anything until retirement. She has mastered investing with a simple three-fund portfolio!