Bogleheads’ Guide to the Three-Fund Portfolio shows how a simple portfolio of three total market index funds outperforms most investors with less risk.
One of the rules of common sense investing is to keep it simple. The three-fund portfolio has long been a simple way to diversify across foreign and domestic stocks, as well as bonds. The Bogleheads’ Guide to the Three-Fund Portfolio is written by a founder of the extremely popular investor forum Bogleheads.org, Taylor Larimore.
Boglehead’s Three Fund Portfolio: perfect for almost everyone
This short book is perfect for novice investors, and experienced investors who either recognize that their investment portfolios are complex or who remain uncertain about why passive investing outperforms active investing. For these investors, the book introduces them to John C. Bogle and some of the practical mechanics of getting started.
The preface to the book describes important lessons he has learned in over 50 years of investing. Along the way he founded the extremely popular investor forum Bogleheads.org where members consolidated their wisdom into common sense investing, also called The Boglehead Investment Philosophy.
The Foreword is by John C. Bogle
Bogleheads is an endearing reference to John C. Bogle, the world’s biggest champion helping ordinary investors get their fair share of market returns.
John Bogle was not only the inventor of (index funds) but the founder of the largest mutual fund company: The Vanguard Group. Yet, this company stands apart from the general wisdom the the investment industry is not your friend.
Let’s face it: Most investment companies are in business to make money from you, not for you. Every dollar you save in commissions and fees expenses goes right to your bottom line.Rick Ferri, CFA, page 1 of this Guide to the Three-Fund Portfolio
Just as the gambling industry wants people to think they can beat the casino, the investment industry wants investors to think they can beat the market. Of course, a few lucky gamblers do beat the casino, but MOST DON’T. It is the same for investors: Some will beat the market, but MOST WON’T.T. Larimore, page 2 of this Guide to the Three-Fund Portfolio
Many in the financial services industry hate indexing because it is difficult for them to make money selling low-cost index funds. The industry spends billions of dollars attempting to convince us that they can help us beat the market by choosing winning individual stocks, bonds and mutual funds for us. (Fact: They cannot.)T. Larimore, page 2 of this Guide to the Three-Fund Portfolio
Twenty Benefits Explained
Rather than say that this book is not for seasoned Bogleheads or index fund investors, I’d like to challenge them to consider the heart of this book: Taylor’s twenty benefits of total market index funds. Look over this list and ask yourself whether you can explain them to a friend or loved one. We all share this responsibility. And if you cannot , then you too will learn something by reading this book.
The Twenty Benefits to Total Market Index Funds (in no particular order)
- There is No Advisor Risk
- No Asset Bloat
- No Index Front Running
- There is No Fund manager Risk
- No Individual Stock Risk
- No Overlap
- There’s No Sector Risk
- No Style Drift
- Low Tracking Error
- Above-Average Return
- Simplified Contributions and Withdrawals
- The Benefit of Consistency
- Low Turnover
- Low Costs
- Maximum Diversification (lower-risk)
- Portfolio Efficiency (best risk/return ratio)
- Low Maintenance
- Easy to Rebalance
- Tax Efficiency
- Simplicity (for investors, caregivers, and heirs)
Simple and elegant for any wealth level
The important lesson from the book is that the three-fund portfolio will work at any wealth level and the simple but elegant solution will give you a worry-free investment life and a worry-free retirement.
Why not 1 fund? Or, 2 funds? Or, 4 funds? The book does not waste time comparing other “lazy portfolios” but it indirectly recognizes them. Sometimes additional simplicity is more valuable than rebalancing flexibility. Other times investors add a fund to overweight small-value stocks—consciously adding more risk for a slightly higher expected return.
All lazy portfolios have different allocations of asset classes, but all include high-quality bond fund for portfolio stability and total market index funds for all their common advantages.
Flexible: Bonds and Foreign Stock allocations
After the bond allocation, which is both most important and most personal, the next key decision is: what percentage of stocks should be in U.S. stocks? And how much in foreign stocks? Good advice on this ranges between 0% and 50%.
I personally choose 2/3 U.S. stocks and 1/3 foreign —for the simple reason that I can tell at a glance if I’m still on track. William Bernstein’s book, If You Can, suggests equal allocation—which is even easier to monitor at a glance. Taylor Larimore’s personal compromise is 80% U.S. stocks and 20% foreign stocks. As always, your exact decision is less important than sticking to your plan.
Taylor encourages using Target Retirement Funds which would be a one-fund solution. These are built with the same building blocks (total market index funds) but often include the Total International Bond Market, whereas other portfolios do not.
Complexity is not useful
The other important lesson from the book is that complexity does not enhance your investment returns. If your building blocks are low-cost index funds, you’ll be fine—although simpler is always better.
Act as if every broker, insurance salesman, mutual fund salesperson and financial advisor you encounter is a hardened criminal, and stick to low-cost index funds, and you’ll do just fine.William J. Bernstein, author of “If You Can”
Plus 45 endorsements from experts!
Allan S. Roth, author and financial planner, often benchmarks portfolios against these three funds.
To say I have rarely seen a portfolio beat this benchmark is an understatement. Typically, the shortfall is substantial even beyond what expenses would have predicted. If you’re thinking complexities such as smart beta and the like, will beat simplicity, think again.Allan S. Roth, author
Finally, it would have defeated the “Keep it simple” message about investing if this book was longer than it is. The core of the book is only 61 pages and can be read and understood in one afternoon. Mission accomplished.
Credibility comes from all the endorsement citations. Appendix I of The Bogleheads’ Guide to the Three-Fund Portfolio is called, “What Experts Say” and you’ll quickly understand that this is world-class wisdom.