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Lazy Investing: What is the Three-Fund Portfolio?

In previous articles, I’ve talked about the benefits of investing, not only as a way of building wealth, as I explained in this article but also as a way of mitigating the effects of inflation. I emphasized how investing isn’t for every situation, but it is an element of finance that everyone should at least consider participating in. Now, you’re likely wondering, “how can I start investing?”, “what does this process entail?” and “what investments should I purchase?”.

To answer those questions, I would suggest you read this article on opening a brokerage account and this article on the different asset classes. Once you’ve familiarized yourself with some of the key ideas and terms involved with investing, come back here.

Now that you know how to get started, let’s get into today’s article. Today, I’ll be discussing one very common approach to investing, the Three-Fund portfolio. The three-fund portfolio is a technique created by an online community of personal investors, dubbed “Bogleheads”, after John Bogle, the creator of the index fund and founder of Vanguard. Fittingly, this strategy utilizes index funds as its basis and revolves around an extreme level of diversification. As a recap, diversification is making something varied or different, meaning you have many small items instead of a few large ones.

To preface, I want to say that I am not a registered financial advisor, everything I say is purely my opinion and for educational purposes only. I am not telling you to use this strategy, I am simply explaining it. Please consult a registered financial advisor before making any investment decisions.

So what are the three funds used by the “Three Fund Portfolio”? The first one is an overall US stock market fund. This means the fund tracks every single stock in the US stock market, meaning you get to own a very small piece of every public company in America (when I said extreme diversification, I meant it). The second fund is an overall US bond market fund, which, again, means you have exposure to every single bond variation in the US, and the third, and most dramatic, is an overall international stock market fund, meaning you literally own an extremely small piece of every single stock in the world!

I’m no mind-reader, but I can almost certainly guess what you’re thinking right now - “Why??”. Well, the goal of the Three Fund Portfolio is simplicity and hands-off investing. In short, you set up this portfolio and let it run on autopilot, so no stock picking is involved. Buy the funds, deposit money every month/year, and enjoy your gains.

Additionally, this portfolio tries to maximize your gains while attempting to minimize risk - you literally own every single stock in the world, and every bond variant in the US. That is as diverse as it gets. Furthermore, this portfolio allows you to adjust your risk exposure freely based on your personal tolerance. This means that as you grow older, and want less risk (in exchange for lower profits), you can allocate more of your portfolio towards the less-volatile bond fund. This can be done with almost extreme ease, unlike actually managing a portfolio of many bonds/stocks. Simply rebalance your portfolio by selling some of your stock-based fund holdings and move cash into the bond fund/

Maybe simplicity, minimalism, and hands-off investing sound like your type of strategy. If so, here's how you can start developing your own three-fund portfolio. Start by opening a brokerage account, which you can read more about here. Ideally, this would be done in some kind of tax-advantaged account. When it comes to brokers, the most common/popular ones are Vanguard, Fidelity, and Charles Schwab. All three are very similar and offer (for the most part) the same services and user experience.

Once you’ve selected a brokerage, simply add money, and find your broker’s version of the three funds (total US stock market fund, total international stock market fund, and total US bond fund). Each broker will have a slightly different name for these funds, but the holdings will be the same. For instance, Charles Schwab has Schwab Total Stock Market Index (SWTSX). Schwab International Index (SWISX), and the Schwab U.S. Aggregate Bond Index Fund. Similarly, Vanguard offers Vanguard Total Stock Market Index Fund (VTSAX), Vanguard Total International Stock Index Fund (VTIAX), and the Vanguard Total Bond Market Fund (VBTLX).

Once you’ve found your broker’s variant of each fund, set up automatic investments, so your account automatically buys a certain amount of each fund every so often. Once you have automatic investments set up, just keep adding money every year, and make sure to check up on your portfolio every 3-4 months.

Setting up and managing this strategy is relatively simple, but if you're still on the fence, I’ll be going over the pros and cons of the Three Fund Strategy next week, so you can make a more informed decision.

In short, the Three Fund Portfolio is an investing strategy intended for hands-off investors and is centered around simplicity. It includes three index/exchange-traded funds, each tracking a different element of the financial markets (US equities, international equities, and US bonds), so an investor would get some exposure to a variety of different companies. To read more about the Three Fund portfolio, check out this wiki page published by the community that created this strategy.

I hope you enjoyed this write-up and learned something new. Thanks for reading, and I’ll see you next week.

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