3-Fund Portfolio: Too Simple or Too Perfect?

The 3 Fund Portfolio: Too Simple or Too Perfect?

There’s always a new investment. A friend exclaiming the rewards of this fund or that.

There’s always a way for you to overcomplicate things.

So, what do you like? Simplicity or complicated?

Let’s examine the 3-fund portfolio, the strategy popularized by the legendary investor Jack Bogle, and compare it to portfolios with multiple funds. Which reigns supreme, both in returns and set-up?

What are the advantages and disadvantages of this strategy and why is it so popular?

And ultimately answer the question: is it too simple or too perfect?

Jack Bogle’s simple strategy, the 3 Fund portfolio, is an approach that focuses on three low-cost funds to achieve broad market exposure. This means, if you have an investment account with X amount of cash, you could achieve diversification and historically good returns with only 3 funds.

Each fund invests in hundreds (if not thousands) of different assets. What are the funds? Firms like Vanguard and Fidelity have similar ones in these classes:

• Total Stock Market Index Fund (VTSAX/FSTMX) - provides broad exposure to the entire U.S. stock market, including large, mid, small, and micro-cap companies.

• Total International Stock Index Fund (VTIAX/FSPSX) - offers exposure to international developed and emerging market stocks, providing diversification outside of the United States.

• Total Bond Market Index Fund (VBTLX/FXNAX) - invests in a wide range of U.S. investment-grade bonds, including government, corporate, and mortgage-backed securities

So, why should you consider a 3-fund approach?

1. Simplicity/Ease of Management: One of the primary advantages of the 3 Fund Portfolio is its simplicity. Bogle himself stated, "Simplicity is the master key to financial success." By focusing on only three funds: a domestic stock market index fund, an international stock market index fund, and a total bond market index fund, investors can easily construct and manage their portfolios. (**Hot tip: he doesn’t mention how much time you will save by implementing this portfolio.)

2. Broad Market Diversification: Diversification is a key aspect of successful investing. By investing in a domestic and international stock market index fund, investors gain exposure to a wide range of companies across various industries in their own country and globally, which reduces risk. The bond market index fund provides stability and income potential.

3. Cost Efficiency: Bogle was a pioneer in advocating for low-cost investing. These funds are passive - they aim to replicate the performance of an index which results in lower expense ratios. Research consistently shows that lower-cost funds tend to outperform higher-cost counterparts over the long term.

4. Consistent Market Returns: Investors who use index funds can benefit from market gains without attempting to outperform the market. According to S&P Dow Jones research, passive investing frequently beats active strategies over time. Investors may be able to get more consistent returns by limiting trading and avoiding expensive fund manager errors.

Well, that sounds great! But I’m giving up something, right? Well, there’s always a trade-off, and it’s important for you to decide what’s best for you.

Some disadvantages:

1. Limited Potential for Outperformance: This strategy may not generate outsized gains. Active investors who rely on market timing or select individual stocks have the potential to outperform the market, but with more risk. Again, research shows that the majority of active fund managers underperform their benchmarks.

2. Exposure to Market Volatility: You’re investing in mutual funds with stock and bond exposure - there is volatility there. However, these are passive funds. The decision to invest in index funds is to let them do the work while you enjoy your daily life. Volatility is not going away, so best not to stress about it each day.

What about returns? This simplicity will probably leave me in the dust on returns!

Think again! Observe the table below to see the 3-fund strategy compared to strategies employed by multi-billion dollar endowment funds, that scrape the globe looking for any investment of any size.

What I haven’t mentioned is the PERCENTAGE of each of the 3 funds. This is personal. It’s about your risk tolerance and time horizon. A simple tool is invest your age in bonds. 31 years old? Invest 31% in bonds. The remaining amount you divide between US and international equity. This is only one argument - you are the CEO of your own financial decisions.

The 3-fund portfolio - I’d like to say it’s simple AND too perfect. It provides a great start for any investor. Low-cost index funds, with diversification and efficiency, may not offer you a 30% annual return each year, but it’s a foundation for growth, capital preservation, and an abundance of free time.

That’s right, Jack. Hopefully, we all get what we don’t pay for.

Save On,

Chris