Three fund portfolio - the evolution?

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Three fund portfolio - the evolution?

Postby clearwater » Sun Mar 24, 2013 6:20 am

It's tax time, and I'm diligently working my way through the process. But while doing the taxes I got to wondering... and this is a question really for Taylor --

what was the "inspiration" for the three fund portfolio? Was there some process that naturally led to its construction (e.g. simplification, tax advantage, no possibility of overlaps, etc)... or did all the three appropriate Vanguard products make it possible (when previously, maybe it never was)?

I'm really very curious on how the three fund version came about. There has to be (as Paul Harvey used to say) a "rest of the story".

---
Taylor's original and excellent post on the three fund portfolio is here:
viewtopic.php?f=10&t=88005
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Re: Three fund portfolio - the evolution?

Postby Taylor Larimore » Sun Mar 24, 2013 3:18 pm

clearwater wrote:
I'm really very curious on how the three fund version came about. There has to be (as Paul Harvey used to say) a "rest of the story."


Clearwater:

My interest in investing is inherited. My grandfather, Christopher Foster Coombs, was one of three principals heading United Founders Group, the largest group of investment trusts (now called mutual funds) in the late 1920s. He was a multi-millionaire who became bankrupt in the 30s (stocks bought on margin).

I began investing in 1950 with a neighborhood investment club and spent most of my life trying to "beat the market" by succumbing to Wall Street's marketing machine, and later succumbing to the lure of market-timing newsletters. When I finally realized that all my time and effort trying to beat the market was unsuccessful, I began reading financial literature (over 300 books) and to study academic research.

A Random Walk Down Wall Street by Professor Burton Malkiel and Bogle on Mutual Funds by our mentor, both based on academic research, were two books that had the greatest influence on me. I found it impossible to read these books and not be convinced of the power of total market indexing and the benefits of simplicity.

Most (not all) Wall Street firms and advisors hate simple portfolios and low-cost indexing because it minimizes or eliminates their services. The Three Fund Portfolio is a tough sell against their billion dollar marketing campaigns. Nevertheless, many leading authorities, mostly academics and conflict-free authors, have gone on record as favoring total market index funds. Excerpts like these helped convince me:
Bill Bernstein: "If you own VTSMX with a bit of foreign and REIT, mixed with your bonds, you're most of the way there."

Jack Bogle: "The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk."

Scott Burns, columnist, author: "The odd are really, really poor than any of us will do better than a low-cost broad index fund." Now that he has become an adviser, Scott recommends more complicated portfolios. :wink:

Andrew Clarke, author: "If your stock portfoliio looks very different from the broad stock market, you're assuming additional risk that may, or may not, pay off."

John Cochrane, President American Finance Association: "The market in aggregate always gets the allocation of capital right."

Jonathan Clements, Wall Street Journal columnist: "If you want a surefire strategy for outpacing most other U.S. stock investors, simply shovel money into an index fund that tracks a broad U.S. market index such as the Wilshire 5000 or the Russell 3000."

Prof. Eugene Fama: "When I talk with pension fund people, what I start with is the market portfolio. That's always one of the optimal portfolio' one can settle on."

Paul Farrell, CBS: Where does Fama invest his retirement money?" In index funds. Mostly the Wilshire 5000."

Rick Ferri, author: "For 99% of the the investing population, I still recommend total stock and total bond market index funds."

Graham/Zweig, authors: "The single best choice for a lifelong holding is a total stock-market index fund."

Alan Greenspan: "Prices in the marketplace are by definition the right price."

Sheldon Jacobs who wrote the first book on no-load fund investing: "The best index fund for almost everyone is the Total Stock Market Index Fund.--The fund can only go wrong if the market goes down and never comes back again, which is not going to happen."

Lawrence Kudlow, CNBC: "I like the concept of the Wilshire 5000, which essentially gives you a piece of the rock of all actively traded companies."

Prof. Burton Malkiel: "I now believe the best general U.S. index to emulate is the broader Wilshire 5,000 Stock Index--not the S&P 500."

Bill Miller, famed fund manager: "With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me."

"Morningstar (10-19-2012) named Vanguard's Total Stock Market Index Fund: "Our favorate U.S. Equity ETF."

Motley Fools: "Invest your long-term moolah in index mutual funds that are designed to track the performance of a broad market index."

Pat Regnier, former Morningstar analyst: "We should just forget about choosing fund managers and settle for index funds to mimic the market."

Ron Ross, author: "Giving up the futile pursuit of beating the market is the surest way to increase your investment efficiency and enhance your financial peace of mind."

Paul Sameulson, Nobel Laureate: "The most efficient way to diversify a stock portfolio is with a low-fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios."

Gus Sauter, retired Chief Investment Officer at Vanguard: "I think a very good way to gain exposure to the stock market is through the Total Stock Market Portfolio on the domestic side."

Bill Schultheis, author: The simplest approach to diversifying your stock market investments is to invest in one index fund that represents the entire stock market."

Charles Schwab: "Only about one out of every four equity funds outperforms the stock market. That's why I'm a firm believer in the power of indexing."

Chandan Sengupta, author: "Use a low-cost, broad-based index fund to passively invest in a little bit of a large number of stocks.

Prof. Jeremy Siegel: "For most of us, trying to beat the market leads to disastrous results."

Ben Stein: "Scholarly work by Burton Malkiel, Eugene Fama and others has proved that it is the rare investor indeed who can outperform the overall market."

"Robert Stovall, investment manager: It's just not true that you can't beat the market. Every year about one-third do it. Of course, each year it is a different group."

Larry Swedroe, author: "Over the last 75-years, investors who simply invested passively in the total U.S. stock Market would have doubled their investment approximately every seven years."

Peter D. Teresa, M* Sr. Analyst: My recommendation: a fund that indexes the entire market, such as Vanguard Total Stock Market Index."

Jason Zweig, Wall Street Journal columnist: "I think a total stock market index fund is not only the simplest, but the very best core investment for most people.

Warren Buffett, famed investor: "There seems to be some perverse human characteristic that likes to make easy things difficult."


Seventeen reasons to select Total Market Index Funds:

1. Low expense ratio.
2. Low Turnover (under 4%)
3. More diversification than any other US stock fund.
4. No stock overlap.
5. No manager changes.
6. No style drift.
7. Additions & withdrawals do not unbalance portfolio.
8. Less worry. Corporations (on average) have been growing for centuries.
9. Never below market's average performance.
10. Contains every style and cap-size.
11. Never needs rebalancing.
12. Past returns are much above average.
13. Extremely tax-efficient.
14. Turns tax-Inefficient stocks into tax-Efficient stocks leaving more room in tax-advantaged accounts.
15. Total market funds avoid "front running."
16. On the Efficient Frontier; maximum return per unit of risk.
17. Simplicity--more free time.

I understand that Certified Financial Planners (CFPs) in Vanguard's Personal Service are now recommending the Three Fund Portfolio for most clients.

Its time has come.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Three fund portfolio - the evolution?

Postby LazyNihilist » Sun Mar 24, 2013 3:37 pm

Thanks again Taylor.
While the Three fund portfolio is simple and efficient. Should Bogleheads also be advised to include TIPS in their bond portion of the portfolio. Perhaps somewhere between 20-50%?
I wonder if Vanguard can come up with a fund that does 75% Total Bond Market and 25% TIPS. That would be awesome. :happy
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Re: Three fund portfolio - the evolution?

Postby Taylor Larimore » Sun Mar 24, 2013 3:47 pm

LazyNihilist wrote:Thanks again Taylor.
While the Three fund portfolio is simple and efficient. Should Bogleheads also be advised to include TIPS in their bond portion of the portfolio. Perhaps somewhere between 20-50%?
I wonder if Vanguard can come up with a fund that does 75% Total Bond Market and 25% TIPS. That would be awesome. :happy


For a young investor with 10% or 20% in bonds, diversified Total Bond Market, in my opinion, is sufficient. Once Total Bond Market is large enough ($10,000) for Admiral status, its probably worthwhile to add a TIPS fund. In a 401K TIPS could be added earlier. No one can accurately predict future performance.

It is our stock/bond allocation that will primarily determine our risk and return--not individual funds.

Best wishes.
Taylor
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Re: Three fund portfolio - the evolution?

Postby peppers » Sun Mar 24, 2013 4:39 pm

I like No. 17, more time with the grandchildren, gardening and fishing.
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Re: Three fund portfolio - the evolution?

Postby rmelvey » Sun Mar 24, 2013 4:44 pm

Taylor,

I have great respect for the three fund portfolio. It is ironic that the more educated I become about the theory of capital markets, the more I appreciate the elegance of the three fund portfolio. My only slight difference is that I think that gold is one of the assets that investors allocate money towards, and should be thought of as part of the market portfolio :happy
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Re: Three fund portfolio - adding gold?

Postby Taylor Larimore » Sun Mar 24, 2013 5:05 pm

rmelvey wrote:Taylor,

I have great respect for the three fund portfolio. It is ironic that the more educated I become about the theory of capital markets, the more I appreciate the elegance of the three fund portfolio. My only slight difference is that I think that gold is one of the assets that investors allocate money towards, and should be thought of as part of the market portfolio :happy

rmelvey:

Total stock market index funds (US & International) hold the market weight in gold stocks. Gold has recently enjoyed excellent performance. However, overweighting (and underweighting) the market can be dangerous. For example:

In 1995 Vanguard's Gold Fund (now called Precious Metals) was the worst performing of ALL Vanguard Funds.
In 1997 Vanguard's Gold Fund fell -38.9%; meanwhile Total Stock Market gained +31.0%

Best wishes.
Taylor
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Re: Three fund portfolio - adding gold?

Postby rmelvey » Sun Mar 24, 2013 5:08 pm

Taylor Larimore wrote:
rmelvey wrote:Taylor,

I have great respect for the three fund portfolio. It is ironic that the more educated I become about the theory of capital markets, the more I appreciate the elegance of the three fund portfolio. My only slight difference is that I think that gold is one of the assets that investors allocate money towards, and should be thought of as part of the market portfolio :happy

rmelvey:

Total stock market index funds (US & International) hold the market weight in gold stocks. Gold has recently enjoyed excellent performance. However, overweighting (and underweighting) the market can be dangerous. For example:

In 1995 Vanguard's Gold Fund (now called Precious Metals) was the worst performing of ALL Vanguard Funds.
In 1997 Vanguard's Gold Fund fell -38.9%; meanwhile Total Stock Market gained +31.0%

Best wishes.
Taylor


Oh I agree about gold stocks. But I mean the actual bullion that investors allocate their money towards. I think when thinking about the global portfolio one should look at what the global weighting of stocks versus bonds is... and perhaps gold bullion as well.
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Re: Three fund portfolio - the evolution?

Postby clearwater » Mon Mar 25, 2013 2:05 am

Thank you again to Taylor for all his contributions to the forum and the three fund portfolio. Although I still slice and dice and have a few more funds, I'm trending closer and closer to the three fund model as well.... I'll probably end up with the "five fund" version, which is pretty close (adds TIPS and REIT).
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Re: Three fund portfolio - the evolution?

Postby 1210sda » Mon Mar 25, 2013 8:58 am

rmelvey wrote:Taylor,

I have great respect for the three fund portfolio. It is ironic that the more educated I become about the theory of capital markets, the more I appreciate the elegance of the three fund portfolio.:happy


That's how I feel also (not so much on gold). I went from 21 mutual funds (in my youth) to just three funds now and I love the simplicity it provides.

Because we have four accounts (Taxable his T IRA, his Roth and her T IRA) we have six positions using the 3 Fund portfolio.

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Re: Three fund portfolio - the evolution?

Postby goodoboy » Mon Mar 25, 2013 10:31 am

Taylor Larimore wrote:
clearwater wrote:It's tax time, and I'm diligently working my way through the process. But while doing the taxes I got to wondering... and this is a question really for Taylor --

What was the "inspiration" for the three fund portfolio? Was there some process that naturally led to its construction (e.g. simplification, tax advantage, no possibility of overlaps, etc)... or did all the three appropriate Vanguard products make it possible (when previously, maybe it never was)?

I'm really very curious on how the three fund version came about. There has to be (as Paul Harvey used to say) a "rest of the story".

---
Taylor's original and excellent post on the three fund portfolio is here:
viewtopic.php?f=10&t=88005


Clearwater:

My interest in investing is inherited. My grandfather, Christopher Foster Coombs, was one of three principals heading United Founders Group, the largest group of investment trusts (now called mutual funds) in the late 1920s. He was a multi-millionaire who became bankrupt in the 30s (stocks bought on margin).

I began investing in 1950 with a neighborhood investment club and spent most of my life trying to "beat the market" by succumbing to Wall Street's marketing machine, and later succumbing to the lure of market-timing newsletters. When I finally realized that all my time and effort trying to beat the market was unsuccessful, I began reading financial literature (over 300 books) and to study academic research.

A Random Walk Down Wall Street by Professor Burton Malkiel and Bogle on Mutual Funds by our mentor, both based on academic research, were two books that had the greatest influence on me. I found it impossible to read these books and not be convinced of the power of total market indexing and the benefits of simplicity.

Most (not all) Wall Street firms and advisors hate simple portfolios and low-cost indexing because it minimizes or eliminates their services. The Three Fund Portfolio is a tough sell against their billion dollar marketing campaigns. Nevertheless, many leading authorities, mostly academics and conflict-free authors, have gone on record as favoring total market index funds. Excerpts like these helped convince me:
Bill Bernstein: "If you own VTSMX with a bit of foreign and REIT, mixed with your bonds, you're most of the way there."

Jack Bogle: "The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk."

Scott Burns, columnist, author: "The odd are really, really poor than any of us will do better than a low-cost broad index fund." Now that he has become an adviser, Scott recommends more complicated portfolios. :wink:

Andrew Clarke, author: "If your stock portfoliio looks very different from the broad stock market, you're assuming additional risk that may, or may not, pay off."

John Cochrane, President American Finance Association: "The market in aggregate always gets the allocation of capital right."

Jonathan Clements, Wall Street Journal columnist: "If you want a surefire strategy for outpacing most other U.S. stock investors, simply shovel money into an index fund that tracks a broad U.S. market index such as the Wilshire 5000 or the Russell 3000."

Prof. Eugene Fama: "When I talk with pension fund people, what I start with is the market portfolio. That's always one of the optimal portfolio' one can settle on."

Paul Farrell, CBS: Where does Fama invest his retirement money?" In index funds. Mostly the Wilshire 5000."

Rick Ferri, author: "For 99% of the the investing population, I still recommend total stock and total bond market index funds."

Graham/Zweig, authors: "The single best choice for a lifelong holding is a total stock-market index fund."

Alan Greenspan: "Prices in the marketplace are by definition the right price."

Sheldon Jacobs who wrote the first book on no-load fund investing: "The best index fund for almost everyone is the Total Stock Market Index Fund.--The fund can only go wrong if the market goes down and never comes back again, which is not going to happen."

Lawrence Kudlow, CNBC: "I like the concept of the Wilshire 5000, which essentially gives you a piece of the rock of all actively traded companies."

Prof. Burton Malkiel: "I now believe the best general U.S. index to emulate is the broader Wilshire 5,000 Stock Index--not the S&P 500."

Bill Miller, famed fund manager: "With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me."

"Morningstar (10-19-2012) named Vanguard's Total Stock Market Index Fund: "Our favorate U.S. Equity ETF."

Motley Fools: "Invest your long-term moolah in index mutual funds that are designed to track the performance of a broad market index."

Pat Regnier, former Morningstar analyst: "We should just forget about choosing fund managers and settle for index funds to mimic the market."

Ron Ross, author: "Giving up the futile pursuit of beating the market is the surest way to increase your investment efficiency and enhance your financial peace of mind."

Paul Sameulson, Nobel Laureate: "The most efficient way to diversify a stock portfolio is with a low-fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios."

Gus Sauter, retired Chief Investment Officer at Vanguard: "I think a very good way to gain exposure to the stock market is through the Total Stock Market Portfolio on the domestic side."

Bill Schultheis, author: The simplest approach to diversifying your stock market investments is to invest in one index fund that represents the entire stock market."

Charles Schwab: "Only about one out of every four equity funds outperforms the stock market. That's why I'm a firm believer in the power of indexing."

Chandan Sengupta, author: "Use a low-cost, broad-based index fund to passively invest in a little bit of a large number of stocks.

Prof. Jeremy Siegel: "For most of us, trying to beat the market leads to disastrous results."

Ben Stein: "Scholarly work by Burton Malkiel, Eugene Fama and others has proved that it is the rare investor indeed who can outperform the overall market."

"Robert Stovall, investment manager: It's just not true that you can't beat the market. Every year about one-third do it. Of course, each year it is a different group."

Larry Swedroe, author: "Over the last 75-years, investors who simply invested passively in the total U.S. stock Market would have doubled their investment approximately every seven years."

Peter D. Teresa, M* Sr. Analyst: My recommendation: a fund that indexes the entire market, such as Vanguard Total Stock Market Index."

Jason Zweig, Wall Street Journal columnist: "I think a total stock market index fund is not only the simplest, but the very best core investment for most people.

Warren Buffett, famed investor: "There seems to be some perverse human characteristic that likes to make easy things difficult."


Seventeen reasons to select Total Market Index Funds:

1. Low expense ratio.
2. Low Turnover (under 4%)
3. More diversification than any other US stock fund.
4. No stock overlap.
5. No manager changes.
6. No style drift.
7. Additions & withdrawals do not unbalance portfolio.
8. Less worry. Corporations (on average) have been growing for centuries.
9. Never below market's average performance.
10. Contains every style and cap-size.
11. Never needs rebalancing.
12. Past returns are much above average.
13. Extremely tax-efficient.
14. Turns tax-Inefficient stocks into tax-Efficient stocks leaving more room in tax-advantaged accounts.
15. Total market funds avoid "front running."
16. On the Efficient Frontier; maximum return per unit of risk.
17. Simplicity--more free time.

I understand that Certified Financial Planners (CFPs) in Vanguard's Personal Service are now recommending the Three Fund Portfolio for most clients.

Its time has come.

Best wishes.
Taylor



Thank you for this good comments and simplicity. I was Xboxlive last night playing video game. And a young guy was recommending a stock tip. I told him buy the total stock index and keep buying it, hopefully he joins boglehead soon. I learned so much here with boglehead, I'm blessed.
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Re: Three fund portfolio - the evolution?

Postby Austintatious » Mon Mar 25, 2013 1:30 pm

Taylor Larimore wrote: , quoted, in part

I understand that Certified Financial Planners (CFPs) in Vanguard's Personal Service are now recommending the Three Fund Portfolio for most clients.

Its time has come.

Best wishes.
Taylor


That may be why the recommendations of funds that Vanguard provides to folks using its Get Your Mutual Fund Recommendation tool, available to anyone using their web site, always comes up with some version of the Three Fund Portfolio, corresponding to the data entered by the customer regarding their personal comfort level with risk, their time horizon, etc. I've tinkered with the tool, putting in data that would suggest I have absolutely no concern about exposure to higher risk and the tool still comes up with some version of the Portfolio, just with a greater allocation to TSM. Certainly, they could be recommending some of their more costly and riskier funds, but they don't, an admirable policy, IMO.
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Re: Three fund portfolio - the evolution?

Postby Barry Barnitz » Tue Mar 11, 2014 2:06 pm

Austintatious wrote:
Taylor Larimore wrote: , quoted, in part

I understand that Certified Financial Planners (CFPs) in Vanguard's Personal Service are now recommending the Three Fund Portfolio for most clients.

Its time has come.

Best wishes.
Taylor


That may be why the recommendations of funds that Vanguard provides to folks using its Get Your Mutual Fund Recommendation tool, available to anyone using their web site, always comes up with some version of the Three Fund Portfolio, corresponding to the data entered by the customer regarding their personal comfort level with risk, their time horizon, etc. I've tinkered with the tool, putting in data that would suggest I have absolutely no concern about exposure to higher risk and the tool still comes up with some version of the Portfolio, just with a greater allocation to TSM. Certainly, they could be recommending some of their more costly and riskier funds, but they don't, an admirable policy, IMO.


It should be noted that Vanguard now recommends a four fund portfolio, adding an allocation to an international bond fund index to the three fund portfolio. This portfolio is tangibly realized with the allocations used by the firm's target date retirement funds, as well as the firm's series of target risk LifeStrategy funds. The Get Your Mutual Fund Recommendation tool, recommends these four funds.
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Adding a "fourth fund?"

Postby Taylor Larimore » Tue Mar 11, 2014 2:34 pm

It should be noted that Vanguard now recommends a four fund portfolio, adding an allocation to an international bond fund index to the three fund portfolio. This portfolio is tangibly realized with the allocations used by the firm's target date retirement funds, as well as the firm's series of target risk LifeStrategy funds. The Get Your Mutual Fund Recommendation tool, recommends these four funds.

Barry:

Thank you for the update. I carefully considered adding Vanguard's International Bond Index Fund to the three fund portfolio. This is what I wrote in an earlier post:

It is always tempting to add additional funds to the Three Fund Portfolio and overlook their additional costs and complexity. International bonds represent a large asset class which Vanguard added to their Target and Life-Strategy funds so their new Total International Bond Fund deserves a look.

It is notable that Vanguard added only a small amount of the new bond fund to their Target and Life Strategy funds. Total International Bond fund represents only 2.0% of the 2060 Target Fund and only 4.0% of the Life Strategy Growth Fund. It's largest allocation is 14% in the Target Retirement Income fund. These allocations are nearly meaningless.

Adding another fund inside a single Target or Life-Strategy fund adds no complexity to the investor. However, I doubt if it is worth complicating the Three Fund Portfolio with another small fund containing several disadvantages: More political risk; higher expense ratios (.23% and .20% Adm.); longer duration (6.6 years) and relatively week credit quality compared with Total Bond Market which is already in The Three Fund Portfolio to provide safety and income.

Best wishes.
Taylor
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