Three fund portfolios for taxable accounts – 2019 update

The Taylor Larimore three-fund portfolio is a portfolio design consisting of three “total” market index funds covering the US stock market, the international stock market, and the US taxable investment grade bond market. However, investors with large taxable accounts and falling in high tax brackets may find that tax-exempt bonds provide higher after-tax returns and would prefer to use an intermediate-term tax exempt bond fund for the portfolio bond allocation in the taxable account.

Investors were able to implement this portfolio beginning in 1997, when Vanguard introduced a total international index fund. The firm had introduced a total US stock market index fund in 1992, and an intermediate US tax-exempt bond fund in 1977. (Tax-exempt bond index funds have limited performance histories, so we are using Vanguard’s low-cost active fund in this analysis.)

The 2019 returns for the portfolio’s constituent Vanguard funds:

  • Vanguard Total Stock Market Index Fund: 30.80%
  • Vanguard Total International Stock Index Fund: 21.51%
  • Vanguard Intermediate Tax-Exempt Bond Fund: 8.71%

Below are four portfolios with allocations devoting 30% of the stock allocation to international stocks (click images to enlarge).

The table below provides 2019 returns for these portfolios. Note that a different weighting of international stocks would result in differing returns.

Year80/2060/4040/6020/80
201923.77%19.52%15.27%11..03%

Historical returns

The following tables give return data for three-fund portfolios. Keep in mind that past returns are no guarantee of future returns, but the history reveals how each portfolio allocation has performed over both the 2000 – 2002 and 2008 bear markets and ensuing recoveries.

With Vanguard having closed investor shares for many index funds, we will use admiral shares for stock indexes starting in 2018. Since the minimum investment for active fund admiral shares remains at $50,000, we use investor shares for the tax-exempt bond fund. Note that prior to 2018, lower cost admiral share portfolios can add approximately +0.10% annual compound return for each allocation.

Three-fund portfolio returns

Year80/2060/4040/6020/80
201923.77%19.52%15.27%11.03%
2018-6.11%-4.27%-2.43%-0.59%
201719.27%15.59%11.90%8.22%
20168.15%6.13%4.11%2.10%
2015-0.31%0.48%1.27%2.07%
20147.39%7.36%7.32%7.29%
201321.97%16.09%10.21%4.32%
201214.59%12.37%10.15%7.92%
2011-1.03%1.63%4.29%6.96%
201012.67%10.03%7.40%4.76%
200926.93%22.75%18.58%14.40%
2008-31.35%-23.55%-15.75%-7.94%
20077.49%6.47%5.46%4.44%
200615.97%13.08%10.20%7.31%
20057.53%6.21%4.89%3.56%
200412.66%10.30%7.94%5.59%
200328.13%22.21%16.29%10.38%
2002-13.77%-8.35%-2.93%2.49%
2001-9.97%-6.21%-2.46%1.30%
2000-7.82%-3.55%0.71%4.98%
199920.41%15.19%9.96%4.73%
199817.92%14.88%11.84%8.80%
199718.59%15.71%12.83%9.96%

Compound returns

The tables below give 3-year, 5-year, 10-year, 15-year, and 20-year compound returns and volatility statistics for each three-fund portfolio allocation.

80/20 allocation

 3-year5-year10-year15-year20-year
CAGR11.49%8.36%9.60%7.41%5.68%
STDev16.11%12.64%10.25%14.53%15.22%

60/40 allocation

 3-year5-year10-year15-year20-year
CAGR9.77%7.12%8.25%6.71%5.58%
STDev12.75%9.99%7.66%11.24%11.52%

40/60 allocation

 3-year5-year10-year15-year20-year
CAGR7.97%5.82%6.83%5.89%5.33%
STDev9.40%7.38%5.27%8.06%7.93%

20/80 allocation

 3-year5-year10-year15-year20-year
CAGR6.10%4.47%5.35%4.93%4.92%
STDev6.06%4.85%3.52%5.19%4.73%

Sharpe ratio

Sharpe ratio80/2070/3060/4040/6020/80
3yr0.660.670.680.700.76
5yr0.640.650.660.700.78
10yr0.930.981.051.231.39
15yr0.480.500.520.580.66
20yr0.320.340.370.460.62

A brief note regarding tax efficiency

Taxable accounts are subject to annual taxation under existing tax regulations, which change over long holding periods. Reducing tax costs is an important consideration for taxable investors. Under current law, consider these points:

  • Long-term capital gains and qualified dividends are taxed at lower rates. In general, index funds tend to realize little or no capital gains distributions and usually provide high levels of qualified dividends.
  • Certain tax-exempt bond interest (from private activity bonds) is subject to taxation under the alternative minimum tax (AMT). Note that the Vanguard active tax-exempt bond funds are permitted to invest up to 20% of their portfolios in private-activity bonds. Currently index funds and exchange-traded funds linked to AMT-free bond indexes are available.

Addendum

Calculated returns data uses this three-fund portfolio for taxable accounts google drive spreadsheet. The spreadsheet contains returns data for an assortment of international stock allocations (20%,40%,50% of the equity allocation).

Calculated returns data uses this three-fund portfolio for taxable accounts google drive spreadsheet. The spreadsheet contains returns data for an assortment of international stock allocations (20%,40%,50% of the equity allocation).

Allocation80/2070/3060/4040/60 20/80
20% internationalCAGRCAGRCAGRCAGRCAGR
3yr11.85%10.95%10.03%8.14%6.18%
5yr8.78%8.11%7.43%6.03%4.57%
10yr10.25%9.49%8.73%7.15%5.51%
15yr7.69%7.32%6.92%6.02%5.00%
20yr5.86%5.81%5.71%5.41%4.97%
30% international
3yr11.49%10.64%9.77%7.97%6.10%
5yr8.36%7.75%7.12%5.82%4.47%
10yr9.60%8.93%8.25%6.83%5.35%
15yr7.41%7.08%6.71%5.89%4.93%
20yr5.68%5.65%5.58%5.33%4.92%
40% international
3yr11.13%10.33%9.50%7.80%6.02%
5yr7.95%7.38%6.81%5.62%4.37%
10yr8.95%8.36%7.76%6.51%5.19%
15yr7.12%6.83%6.50%5.75%4.87%
20yr5.49%5.49%5.44%5.24%4.88%
50% international
3yr10.77%10.01%9.24%7.62%5.93%
5yr7.53%7.02%6.50%5.41%4.27%
10yr8.30%7.80%7.28%6.19%5.03%
15yr6.82%6.58%6.29%5.61%4.80%
20yr5.29%5.32%5.30%5.15%4.84%
Tagged with: