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Retirement planning frequently seems like an unwelcome experience of having too many options. Generally, workplace 401(k) plans offer over a dozen mutual fund options from which to select your retirement investment portfolio. And if you’re saving for retirement through an individual retirement account (IRA), you might have access to thousands of mutual funds.
Breathe deeply; a three-fund portfolio can provide all the asset allocation and diversification you require. Yes, you can achieve financial success with just three funds.
What is the 3-Fund Portfolio?
The 3-fund portfolio is a simple and effective strategy for building a diversified retirement portfolio. It involves investing in three broad-market index funds:
- Total Stock Market Index Fund: This fund invests in a wide range of U.S. stocks, providing broad exposure to the U.S. stock market.
- Total International Stock Index Fund: This fund invests in a wide range of stocks from developed and emerging markets outside the U.S., diversifying your portfolio beyond the U.S. market.
- Total Bond Market Index Fund: This fund invests in a wide range of U.S. bonds, providing stability and income to your portfolio.
Benefits of the 3-Fund Portfolio:
- Simplicity: The 3-fund portfolio is easy to understand and manage, making it ideal for investors of all experience levels.
- Diversification: By investing in three broad-market index funds, you are effectively diversifying your portfolio across different asset classes, sectors, and geographies. This helps to reduce risk and improve your chances of achieving your long-term financial goals.
- Low Cost: Index funds typically have low expense ratios, which means more of your money is working for you instead of going towards fees.
- Tax Efficiency: Index funds are generally tax-efficient, meaning you pay less in taxes on your investment gains.
How to Build a 3-Fund Portfolio:
- Determine Your Asset Allocation: The first step is to determine how much you want to invest in stocks and bonds. This will depend on your age, risk tolerance, and time horizon. A general rule of thumb is to allocate more to stocks when you are younger and gradually shift towards bonds as you get closer to retirement.
- Choose Your Funds: Once you have determined your asset allocation, you need to choose specific funds to invest in. Look for low-cost index funds with a proven track record.
- Rebalance Regularly: Over time, the performance of your funds will likely cause your asset allocation to drift. It is important to rebalance your portfolio periodically to ensure that it remains aligned with your target asset allocation.
Example 3-Fund Portfolio:
- Vanguard Total Stock Market Index Fund (VTI): 60%
- Vanguard Total International Stock Index Fund (VXUS): 30%
- Vanguard Total Bond Market Index Fund (BND): 10%
The 3-fund portfolio is a simple and effective strategy for building a diversified retirement portfolio, It is suitable for investors of all experience levels and can help you achieve your long-term financial goals,
Additional Resources:
- Bogleheads Wiki: Three-fund portfolio
- Forbes Advisor: 3 Fund Portfolio: How To Save For Retirement With Just Three Investments
FAQs:
- What is the best asset allocation for a 3-fund portfolio?
The best asset allocation for a 3-fund portfolio depends on your individual circumstances. However, a general rule of thumb is to allocate more to stocks when you are younger and gradually shift towards bonds as you get closer to retirement.
- What are some good index funds to use in a 3-fund portfolio?
Some good index funds to use in a 3-fund portfolio include the Vanguard Total Stock Market Index Fund (VTI), the Vanguard Total International Stock Index Fund (VXUS), and the Vanguard Total Bond Market Index Fund (BND).
- How often should I rebalance my 3-fund portfolio?
It is recommended to rebalance your 3-fund portfolio at least once a year. However, you may need to rebalance more frequently if your asset allocation has drifted significantly.
- Is the 3-fund portfolio right for me?
The 3-fund portfolio is a good option for many investors, but it is important to consider your individual circumstances before making a decision. If you are unsure whether the 3-fund portfolio is right for you, it is best to consult with a financial advisor.
How to Build a 3-Fund Portfolio
Here’s how to save for retirement using the three-fund strategy:
Focus on Broad-Market Index Funds
Henderson states, “Your objective is to own the market, not beat the market.” Think that’s settling? It’s anything but. Morningstar’s annual review of active vs. Evidence from passive funds demonstrates that, in the long run, very few actively managed funds—wherein experts personally select each investment—manage to outperform inexpensive index funds that merely aim to replicate the performance of the market as a whole.
In addition, there are “total” bond funds and broad total market index international stock funds.