The Three Fund Portfolio, also called the Lazy Portfolio, is a simple yet popular portfolio amongst passive index investors. It is designed to provide broad diversification across the stock and bond markets while incurring minimal costs, taxes, and overhead.
While there is no single inventor of the three-fund portfolio, Taylor Larimore is often credited with coining the term "three-fund portfolio" after publishing this post in 2012 on the Bogleheads forum.
Assets
There are many other fund options available from various providers, but these Vanguard ETFs often used because of their low expense ratios and broad diversification. Investors may choose other funds based on their individual preferences, but it's important to ensure that the funds have low costs and provide broad market exposure.
For the total stock market index, Vanguard offers both an ETF (VTI), and a mutual fund (VTSAX). Because VTSAX is a mutual fund, it requires a minimum investment, and you can buy or sell shares just once per day. Their expense ratios are the same at the time of this writing, at 0.03%. We choose VTI for its greater flexibility.
For the total international stock index fund, Vanguard offers both an ETF (VEU), and a mutual fund (VTIAX). We use VEU for similar reasons as VTI.
And for total bond exposure, Vanguard offers the mutual fund VBTLX, and the ETF BND. We, again, choose the ETF.
Weights
There is no standard allocation between these funds, as the specific weights of each fund depend on the investor's risk tolerance, time horizon, and investment goals. Our model portfolio is designed for a 30-year old investor based on the following rules of thumb.
The "age in bonds" rule is popular within the passive investing community, and is suggested by Taylor Larimore in his book, "Bogleheads' Guide to Investing." This rule recommends that an investor should subtract their age from 100 (or 110) to determine the percentage of their portfolio that should be invested in stocks, with the remainder allocated to bonds.
For example, a 30-year-old investor would allocate 70% to stocks and 30% to bonds, while a 60-year-old investor would allocate 40% to stocks and 60% to bonds.
Vanguard generally uses a 60/40 US / International stock split in similar target date retirement funds designed for investors who are roughly 30 years old.
Using these two rules of thumb, we allocate 30% to BND, 42% to VTI, and 28% to VEU.
Vanguard offers this Questionnaire to help investors determine weights suitable to them.
Rebalancing
Given the passive nature of this portfolio, we employ a periodic rebalancing cadence of every 365 days to ensure long term capital gains are incurred in the US jurisdiction should this portfolio be managed in an account that is not tax advantaged.
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We also employ minimum and maximum allocation thresholds of +/- 30% from the target allocations. These thresholds tolerate ample room for allocation drift because of the high level of diversification in each fund, and to preserve the nature of a passive investment approach.
Performance
The 3 Fund portfolio has not generated as much growth as many other standard portfolios over the past dozen years. It's sharp ratio leaves some to be desired as well.
It has, however, done its job in offering broad diversification. This has resulted in less volatility than portfolios with greater concentrations in large cap US stocks.
The 3 Fund is therefore an option for investors who may prefer shorter term wealth preservation over longer term growth.
If you'd like to implement the 3 Fund portfolio, or perform your own analysis on it, you can use Wealthview's free back testing and portfolio management tools.
To your sovereignty,
Sal
