What Is the Three-Fund Portfolio Strategy?

Investing can be complicated. For this reason, it may be hard to understand where you should allocate your money or how to use it to reach your goals, such as retirement. The three-fund portfolio, on the other hand, aims to simplify how you invest, so that you’re on track toward your goals while balancing risk and reward.

The three-fund portfolio is a time-tested approach that many investors put to use. However, it’s important to have a basic understanding before considering it. In this article, we’ll provide an overview of how the approach works, what it consists of, and the pros and cons.

Understanding the Three-Fund Portfolio

The three-fund portfolio is an asset allocation strategy initially conceptualized and espoused by the late John “Jack” Bogle, the founder of Vanguard. It involves holding three mutual funds or ETFs which give you a broad range of diversification. Rather than trying to time the market, the strategy embodies a buy-and-hold mindset that favors long-term gains.

The three-fund portfolio is fundamentally about investing in basic asset classes – namely, stocks and bonds. Thomas J. Brock, CFA, CPA, an expert contributor at RetireGuide.com, says that a typical portfolio of this style “consists of three distinct funds – a domestic stock fund, an international stock fund, and a bond fund.” Constructing a portfolio this way “can make sense within a retirement account or a taxable brokerage account,” he continues.

Below is a breakdown of the three funds that make up this approach:

• Domestic stock index fund. These are typically “total market” funds that expose investors to various sectors of the U.S. economy. Often, they provide growth opportunities but also can come with the risk of volatile market conditions.
• International stock index fund. These are funds that track international stocks from a variety of sectors. By investing in them, investors become less reliant on the performance of U.S.-based equities, helping them manage risk within their portfolios.
• Bond index fund. These funds invest in a variety of fixed-income securities. Typically, they help manage risk while providing modest returns.

As an example, a three-fund portfolio asset allocation at equal weights may look like:

• Vanguard Total Stock Market Index Fund (VTSAX) – 34%
• Vanguard Total International Stock Index Fund (VTIAX) – 33%
• Vanguard Total Bond Market Fund (VBTLX) – 33%

Which Funds to Include

The simplicity and diversification benefits of the three-fund approach make it a popular option for DIY investors, especially those planning for retirement with a long time horizon. However, Brock explains that it’s crucial to maintain “an asset allocation that reflects your tolerance for risk.” This can be accomplished by weighing your risk tolerance and time horizon, then, ideally with the help of an advisor, making an informed decision on how you should construct your portfolio.

“Generally, an investor with a long time horizon has a relatively high tolerance for risk and should maintain an asset allocation that favors the stock funds,” Brock states. On the other hand, he says that “an investor with a short time horizon has a relatively low tolerance for risk and should maintain an asset allocation that favors the bond fund.”

Pros and Cons of the Three-Fund Portfolio

The three-fund portfolio provides a simple approach for people to invest for the long term. By only placing your cash in three separate funds, you diversify your portfolio while earning sustained returns over time as the market grows. This also makes the strategy ideal for DIY investors, who may not have the time or expertise to monitor and rebalance a complex portfolio.

While setting your portfolio up in this way may be effective, there are downsides you should consider. The first is that, with passive management, “you could be leaving some opportunity on the table,” warns Joe Schmitz Jr., CFP^®, ChFC, CKA, founder and CEO at Peak Retirement Planning. This is because, with only three funds in your portfolio, you may miss out on potentially higher-growth securities.

Something else to consider is that, while the three-fund portfolio is relatively simple, it isn’t just something you’re supposed to keep the same forever. It’ll be up to you (or a financial advisor) to consistently monitor your asset allocation to ensure it’s keeping you on track to your goals.

How to Get Started

To start an effective three-fund portfolio, you first must consider your goals, risk tolerance, and time horizon. That is, what do you hope to achieve, how much money are you willing to risk, and when do you envision reaching your goals? These factors will inform which funds you invest in and any rebalancing you do to keep yourself on track.

Once you understand your preferences, it’s time to purchase shares of the funds that align with your needs. You can do so through an online brokerage firm, either with a taxable brokerage or a tax-advantaged retirement account. As mentioned, the three-fund portfolio typically consists of a domestic index fund, an international index fund, and a bond index fund.

In general, supporters of the classic three-fund portfolio refer to Vanguard’s core funds (referenced in an example above). It’s possible, however, to build a similar version with other fund providers, such as Fidelity and Charles Schwab.

Keep in mind that, as Brock explains above, the amount you allocate to each fund should hinge on your objectives and circumstances. For this reason, we recommend consulting with an advisor or investment manager before you construct your portfolio, even if you decide to handle it yourself.

If you need help finding a professional, we recommend using this free matching tool to narrow your search. After filling out a brief quiz regarding your current situation and investment preferences, it’ll pair you with a professional that suits your needs.

Frequently Asked Questions

Can you use the three-fund portfolio for the short term?

It’s possible to use the three-fund portfolio for the short term; however, with less time until you reach your goal, your asset allocation will need to reflect it. This typically is reflected by a portfolio that leans more heavily on bond funds than domestic and international stocks, which can be prone to volatility. With that in mind, we suggest you consult with a financial advisor before you commit to any investment strategy.

Should you rebalance a three-fund portfolio?

Yes, you should consistently monitor and rebalance a three-fund portfolio. This ensures you remain on track to your goals. You can accomplish either on your own or with the help of a professional.

Do I need a financial advisor if I use the three-fund portfolio?

While the three-fund portfolio is popular for DIY investors, it’s always beneficial to work with a financial advisor. They can help you ensure you have the most optimal asset allocation for your needs. Additionally, a professional can assist with other aspects of your finances, such as planning for retirement or short-term goals, like buying a home.