The following article is for educational and entertainment purposes only, and should not be considered financial advice. Please contact a licensed financial professional for individualized financial advice. Below links may be affiliate links that generate a small commission for the site at no cost to you.
It's no secret that investing is a critical component of building wealth and achieving financial independence. However, with so many investment options available, it can be challenging to decide where to put your money. Do you invest in index funds on the advice of Graham Stephan? Do you pile into Bitcoin like your favorite Pompliano brother? Do you read "The Intelligent Investor" and decide to become an expert in moats? Or how about YOLO'ing your life savings into the most popular WallStreetBets trend? Well, I might have an easier solution for you: The 3-Fund Portfolio.
What Is The 3-Fund Portfolio?
The 3-Fund portfolio is a popular investment strategy that offers a simple and effective approach to investing.
The concept behind the 3-Fund portfolio is to invest in three fundamental types of assets: stocks, international stocks, and bonds. By diversifying across these three asset classes, you can achieve a well-diversified investment portfolio that is easy to manage and can deliver solid, back-tested returns over the long term.
Let's take a closer look at each of the three funds that make up the 3-fund portfolio:
Total Stock Market Index Fund
The first fund is a Total Stock Market Index Fund, which invests in a broad range of stocks across the entire U.S. stock market. This includes small-cap, mid-cap, and large-cap stocks, giving investors exposure to the full spectrum of the U.S. stock market.
One of the advantages of a Total Stock Market Index Fund is that it is a low-cost, passive way to invest in the stock market. Instead of trying to pick individual stocks, which can be risky and time-consuming, you can invest in the entire market and capture its overall performance.
Another advantage of a Total Stock Market Index Fund is that it is highly diversified. Because it invests in so many different stocks, it spreads your investment risk across a wide range of companies and sectors. This reduces the risk of any single stock or sector significantly impacting your overall investment returns, assuming the ass doesn't fall out of the market like it has 4 times over the last 20 years.
Total International Stock Index Fund
The second fund in the 3-Fund portfolio is a Total International Stock Index Fund, which invests in a broad range of international stocks across developed and emerging markets outside of the U.S.
Investing in international stocks can offer several benefits to investors. First, it provides exposure to companies and industries that may not be available in the U.S. market. This can be beneficial if you're looking to diversify your portfolio further or take advantage of growth opportunities in other countries that may be on the rise faster than some more-developed economies.
Second, investing in international stocks can reduce your overall investment risk. By investing in companies in different countries and regions, you're spreading your investment risk across a more diverse range of companies and economies.
Like the Total Stock Market Index Fund, the Total International Stock Index Fund is a low-cost way to invest in a broad range of stocks. This makes it an attractive option for investors looking to diversify their portfolio and capture the growth potential of international markets.
Total Bond Market Index Fund
The third fund in the 3-fund portfolio is a Total Bond Market Index Fund, which invests in a diversified mix of U.S. government and corporate bonds.
Related: How Do Bonds Work?
Bonds are a critical component of a well-diversified investment portfolio. They are less volatile than stocks and can provide a steady stream of income to investors. Bonds also tend to be less correlated with the stock market, meaning they can provide a hedge against market downturns. If you think about your portfolio like a car, then the income generated by the bond index is like the gasoline that actually makes it run. And also the airbag that protects against accidents...?
The Total Bond Market Index Fund invests in a broad range of bonds, from short-term Treasury bonds to longer-term corporate bonds. This provides investors with exposure to different types of bonds and can help spread investment risk across a range of bond types.
One of the advantages of a Total Bond Market Index Fund is that it is a low-cost way to invest in the bond market. Unlike individual bonds, which can require significant upfront capital and expertise, a bond index fund allows investors to gain exposure to a diversified mix of bonds with minimal investment costs.
Benefits of The 3-Fund Portfolio
The 3-fund portfolio offers several benefits to investors. First, it is simple and easy to manage. By investing in just three funds, you can achieve a well-diversified investment portfolio that captures the performance of the stock and bond markets.
Second, the 3-fund portfolio is cost-effective. Because the funds used in this strategy are low-cost index funds, the investment fees are relatively low. This means more of your investment dollars are going towards growing your portfolio rather than paying investment fees.
Third, the 3-fund portfolio is highly customizable. You can adjust the allocation of funds based on your risk tolerance, investment objectives, and time horizon. For example, if you're younger and have a longer investment horizon, you may want to allocate more of your portfolio to stocks. If you're closer to retirement and have a shorter investment horizon, you may want to allocate more of your portfolio to bonds.
Finally, the 3-fund portfolio has a strong historical track record of delivering solid returns over the long term. While past performance is not a guarantee of future results, the 3-fund portfolio has a proven history of outperforming many actively managed funds and achieving consistent returns.
How to Implement the 3-Fund Portfolio
Implementing the 3-fund portfolio is relatively simple. Here's how to get started:
Determine your investment objectives and risk tolerance: Before you start investing, it's essential to define your investment objectives and risk tolerance. This will help you determine the appropriate allocation of funds in your portfolio.
Choose your funds: The 3-Fund portfolio consists of a Total Stock Market Index Fund, a Total International Stock Index Fund, and a Total Bond Market Index Fund. You can choose the specific funds that best meet your investment objectives and risk tolerance.
Determine your asset allocation: The asset allocation refers to the percentage of your portfolio that you allocate to each of the three funds. The ideal asset allocation depends on your investment objectives and risk tolerance. A common asset allocation for the 3-Fund portfolio is 50% Total Stock Market Index Fund, 30% Total International Stock Index Fund, and 20% Total Bond Market Index Fund.
Rebalance your portfolio: Once you've implemented the 3-Fund portfolio, it's essential to rebalance your portfolio periodically to maintain the appropriate asset allocation. Rebalancing involves selling and buying funds to bring your portfolio back to its target asset allocation.
Conclusion
The 3-fund portfolio is a simple and effective investment strategy that can help investors achieve a well-diversified and balanced investment portfolio. By investing in a Total Stock Market Index Fund, a Total International Stock Index Fund, and a Total Bond Market Index Fund, you can capture the performance of the stock and bond markets while minimizing investment fees and risks. The 3-Fund portfolio is highly customizable and has a proven track record of delivering solid returns over the long term. Whether you're a new investor or an experienced one, the 3-Fund portfolio is an excellent option to consider for building long-term wealth.
