Vanguard founder Jack Bogle revolutionized investing by introducing simple index funds. These funds offer investors instant portfolio diversification and come with low expense ratios.
Bogleheads, investors who swear by Bogle strategies, say investors can achieve their goals with a simple three-fund portfolio made up of index funds. Here’s what you need to know if you’re looking for a hard-working investment strategy to help pay for your retirement and other long-term goals.
What is a three-bag portfolio?
A three-fund portfolio consists of the following funds:
- UStotal stock market index fund, which provides broad exposure to the entire US stock market
- An international stock market index fund, which tracks the performance of non-US stocks and can be a valuable differentiator
- A US bond index fund, which provides exposure to a wide variety of bonds across multiple sectors and maturities
Vanguard offers all three of these funds, Vanguard Total Stock Market Index Fund Admiral Shares (VTSEX), Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) and Vanguard Total Bond Market Index Fund Admiral Shares (VBTX). But you can also buy mutual funds from other providers of mutual funds and exchange-traded funds (ETFs), including Fidelity Investments and Charles Schwab.
Why does the strategy work?
These funds are baskets of securities, meaning you are not dependent on the performance of a single stock or bond to generate returns. They provide diversification, meaning that while one area of your portfolio is struggling, another should hold steady or even outperform.
These funds often come with low fees. Index funds typically have fees below 0.05%, while many actively managed funds have fees above 0.50%. A 0.05% expense ratio on a $500,000 portfolio comes to just $250 in annual fees. But an average fee of 0.50% on the same amount results in $2,500 in payments per year.
Also, the Bogleheads approach keeps things simple for investors.
How to set up a portfolio
If you are using a three-fund portfolio, it is important to allocate these three funds based on your goals, time horizon and risk tolerance. Someone who has decades before retirement will likely have a higher share of the two equity funds than someone who is about to retire.
There is no hard and fast rule about allocation. Bogle said investors’ bond allocation should be proportional to their age. For example, a 60-year-old can put 60% of his portfolio in bonds. But not everyone agrees with this approach. Some investors prefer to hold their minus-10 years or their minus-20 years in bonds.
Once you’ve set up a portfolio, your work isn’t over. It’s important to regularly review your asset allocation to ensure it aligns with your goals and risk tolerance. If not, it’s time to rebalance, which includes selling assets that exceed your assigned quota, and buying assets that have fallen below their supply limit.
