The Three-Fund Portfolio

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Taylor Larimore
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Another nice article about The Three-Fund Portfolio

Post by Taylor Larimore » Mon Oct 09, 2017 8:43 pm

Bogleheads:

I was alerted to this nice article about The Three-Fund Portfolio:

The Three Fund Investment Portfolio: The Beauty of Simplicity

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Another nice article about The Three-Fund Portfolio

Post by bertilak » Tue Oct 10, 2017 9:10 am

Taylor Larimore wrote:
Mon Oct 09, 2017 8:43 pm
Bogleheads:

I was alerted to this nice article about The Three-Fund Portfolio:

The Three Fund Investment Portfolio: The Beauty of Simplicity

Best wishes.
Taylor
Love the Warren Buffett quote:
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Listen very carefully. I shall say this only once. (There! I've said it.)

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Re: Another nice article about The Three-Fund Portfolio

Post by Hiwatter » Fri Oct 13, 2017 12:15 pm

Taylor Larimore wrote:
Mon Oct 09, 2017 8:43 pm
Bogleheads:

I was alerted to this nice article about The Three-Fund Portfolio:

The Three Fund Investment Portfolio: The Beauty of Simplicity

Best wishes.
Taylor
Excellent article and well written. I forwarded it some family members that continue to use Edward Jones... wish I convince them to convert to the 3-fund portfolio... maybe someday.

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Re: The Three-Fund Portfolio

Post by PuddlesTheDuck » Tue Oct 17, 2017 2:10 pm

I’ve read through a good part of this thread and some other ones and it seems Boglegeads have a serious aversion to international bonds, especially in this thread. If we believe in the value of diversification (which I hope we do) and believe in dicersification via international exposure (which I know some people don’t), why don’t we as a community believe in international bonds? Historically they have been both very stable (giving us the security that people seek in bonds) and very cheap (we have a vanguard index fund for them now).

It seems that the 3 fund portfolio for people who believe the above would be:

Total World Stock Index Fund (VTWSX)
Total US Bond Index Fund (VBTLX)
Total International Bond Index Fund (VTABX)

The only downside here is there aren’t admiral shares yet for the stock index. What do people think? Are we presenting ourselves with too much home country bias by only investing in US bonds?

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Re: The Three-Fund Portfolio

Post by Taylor Larimore » Tue Oct 17, 2017 2:32 pm

Bogleheads:

Barry Barnitz has published updated figures for The Three-Fund Portfolio HERE.

Thank you, Barry!

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: The Three-Fund Portfolio

Post by sbaTexas » Fri Oct 20, 2017 5:38 pm

If one treats their entire portfolio as “one bag,” therefore spreading the 3 fund portfolio across taxable, iras, 401ks etc, would one need to change anything if they are retiring early? I’m looking to retire at 55 but I currently keep all of my bonds in IRA’s and 401k’s, while using taxable accounts for US and intl stock. I’ve been blessed and now my 401ks and IRA’s are composed mostly of bonds as to stay true to my AA, whereas my taxable account is all US and intl stock. Would I need to start doing a 3 fund portfolio within each “bucket” if I wanted to retire early and only live off of my taxable account for several years?

I’ve been so focused on the accumulation years for so long I haven’t really thought about the logistics of when I retire. Any advice would be appreciated.

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Re: The Three-Fund Portfolio

Post by aj76er » Fri Oct 20, 2017 6:09 pm

sbaTexas wrote:
Fri Oct 20, 2017 5:38 pm
If one treats their entire portfolio as “one bag,” therefore spreading the 3 fund portfolio across taxable, iras, 401ks etc, would one need to change anything if they are retiring early? I’m looking to retire at 55 but I currently keep all of my bonds in IRA’s and 401k’s, while using taxable accounts for US and intl stock. I’ve been blessed and now my 401ks and IRA’s are composed mostly of bonds as to stay true to my AA, whereas my taxable account is all US and intl stock. Would I need to start doing a 3 fund portfolio within each “bucket” if I wanted to retire early and only live off of my taxable account for several years?

I’ve been so focused on the accumulation years for so long I haven’t really thought about the logistics of when I retire. Any advice would be appreciated.
No, keep your asset allocation as it is. As you sell stocks in taxable, you'll subsequently buy them in your other accounts (all else being equal).

See the wiki article here: https://www.bogleheads.org/wiki/Asset_a ... e_accounts

I think the "buckets and pitchers" analogy really helps understand what is happening.
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

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Jack Bogle endorses The Three-Fund Portfolio

Post by Taylor Larimore » Tue Oct 24, 2017 8:45 pm

Bogleheads:

No one in the mutual fund industry has a greater combination of impeccable character, practical experience, inventive genius, literary ability, kindness, modesty and the desire to help others than Jack Bogle.

I have just finished reading Jack's great new book (he has written 11) "The Little Book of Common Sense Investing --10th Anniversary Edition." Jack endorses "The Three-Fund Portfolio" with these excerpts:
"Simple arithmetic suggests, and history confirms, that the winning strategy for investing in stocks is to own all of the nations's publicly held businesses at very low cost."

"The traditional index fund by definition, basically represents the entire stock market basket, not just a few scattered eggs. It eliminates the risk of picking individual stocks, the risk of emphasizing certain market sectors, and the risk of manager selection. Only stock Market risk remains."

"The traditional (total market) index fund operates with minimal expenses and with no advisory fees, with tiny portfolio turnover, and with high tax efficiency."

"Simply buy a Standard and Poor's 500 Index fund or a total stock market index fund. Then, once you have bought your stocks, get out of the casino--and stay out. Just hold the market portfolio forever."

"When there are multiple solutions to a problem, choose the simplest one. By far the simplest way to own all of U.S. business is to hold the total stock market portfolio or its equivalent."

"Instead of joining the crowd of investors who dabble in complex algorithms or other machinations to pick stocks, or who look to past performance to select mutual funds, or who try to outguess the stock market (for investors in the aggregate, the three inevitably fruitless tasks), choose the simplest of all solutions--buy and hold a diversified, low-cost portfolio that tracks the stock market."

"Before costs, beating the market is a zero-sum game. After costs, it is a loser's game."

"Since 1980, stock returns have averaged 11.5 percent per year, and the average fund has provided a nontrivial--but clearly inadequate return of 10.1 percent."

"The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing. Just stay the course."

"Assuming that the future is like the past, you can outperform 80 percent of your fellow investors over the next several decades by investing in an index fund and doing nothing else." -- Mark Hulbert, editor of the highly regarded Hulbert Financial Digest.

"Don't look for the needle in the haystack. Just buy the haystack."

"The simplicity of a broad-market, low-cost index fund, bought and then held forever, is likely to be the optimal strategy for the vast majority of investors."

"Profit from the Majesty of Simplicity and Parsimony. Hold traditional low-cost index funds that track the stock market."

"S&P reports that its international index (world markets, less U.S. stocks) outpaced 89 percent of actively managed international equity funds over the past 15 years."

"It may not be as exciting as gambling, but owning the traditional stock market index fund at rock-bottom cost is the ultimate strategy."

"Try to beat the market in any manner and you're likely to get beaten by the cost of doing so." --Jim Wiandt, founder of ETF.com

"In recent years, "smart beta" ETFs (whatever exactly that means) have become a hot product. -- They focus on weighting portfolios by so-called factors.--The goal is to create great profits for the manager by gathering the assets of investors seeking a performance edge."

"Traditional market-cap weighted index funds (such as the Standard & Poor's 500) guarantee that you will receive your fair share of stock market returns, and virtually assure that you will outperform, over the long term, at least 90 percent of the other investors in the marketplace."

"The greatest enemy of a good plan is the dream of a perfect plan."

"Betting against the market (and spending a considerable amount of money to do so) is indeed likely to be a hazardous undertaking. Smart beta is stupid." -- William Sharpe, Nobel Laureate in economics.

"Don't think you know more than the market; no one does. And don't act on insights that you think are your own but are usually shared by millions of others."

"Deep down, I remain absolutely confident that the vast majority of American families would be well served by owning their equity holdings in a Standard & Poor's 500 Index Fund (or a total stock market index fund) and holding their bonds in a total bond market index fund."
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Taylor Larimore endorses the Three-Fund Portfolio

Post by LadyGeek » Tue Oct 24, 2017 10:16 pm

Taylor Larimore wrote:
Tue Oct 24, 2017 8:45 pm
I have just finished reading Jack's great new book (he has written 11) "The Little Book of Common Sense Investing --10th Anniversary Edition." Jack endorses "The Three-Fund Portfolio" with these excerpts:
The discussion thread is here: "Little Book of Common Sense Investing--10th Anniversary Edition" A Gem

Also, Jack Bogle has written the introduction to Taylor's new book. See: Taylor's New Book: The Bogleheads' Guide to The Three-Fund Portfolio
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

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Re: The Three-Fund Portfolio

Post by TD2626 » Wed Oct 25, 2017 12:16 am

PuddlesTheDuck wrote:
Tue Oct 17, 2017 2:10 pm
I’ve read through a good part of this thread and some other ones and it seems Boglegeads have a serious aversion to international bonds, especially in this thread. If we believe in the value of diversification (which I hope we do) and believe in dicersification via international exposure (which I know some people don’t), why don’t we as a community believe in international bonds? Historically they have been both very stable (giving us the security that people seek in bonds) and very cheap (we have a vanguard index fund for them now).

It seems that the 3 fund portfolio for people who believe the above would be:

Total World Stock Index Fund (VTWSX)
Total US Bond Index Fund (VBTLX)
Total International Bond Index Fund (VTABX)

The only downside here is there aren’t admiral shares yet for the stock index. What do people think? Are we presenting ourselves with too much home country bias by only investing in US bonds?
This is a three-fund portfolio, but it is not The Three Fund Portfolio as discussed in this thread. I do feel like your three-fund proposal would be reasonable for an investor tolerant of the currency and political risk that comes with a high international allocation, though.

It's worth noting that this example is an example of one of a large number of very similar portfolios to The Three-Fund Portfolio that are roughly equivalent in spirit even though they don't use Vanguard Total Stock, Vanguard Total International Stock, and Vanguard Total Bond.

For example, investors who buy roughly equivalent index funds to Vanguard Total Stock, Vanguard Total International Stock, and Vanguard Total Bond managed by another fund company (like Fidelity, Schwab, or Blackrock) are reasonably likely to get very similar outcomes. Similarly, investors who do something like Total World + Total Bond or use a Vanguard Life Strategy or Vanguard Target Date fund are also doing things that are fairly similar to the three-fund philosophy. The options (including Vanguard LifeStrategy or Vanguard Target Date) that add international bonds, though. International bonds weren't originally envisioned in The Three Fund Portfolio, so there may be more of a difference in outcomes. I've even heard of Vanguard Total Stock + Vanguard Total World + Vanguard Total Bond three fund ideas suggested by posters that want to have an international allocation partly float with market cap while maintaining a home country bias.

Some people probably view the Three Fund Portfolio as a core element of a larger portfolio - it's used as a springboard to attach on other more exotic assets or tilts. While this could work for some, given that a core goal of the Three Fund Portfolio is simplicity, this may sort of be missing the point and defeating the purpose of the portfolio. Remember that the Three Fund Portfolio as proposed doesn't have specific suggested allocations. Investors have to determine their own ratios between the funds based on willingness, ability, and need to take risk.

It's probably best, though, to recognize that there's a hierarchy of investment decision importance. The most important decision is about the portfolio itself. Are you going to have a portfolio at all? Being prudent and frugal, and living below one's means, is the difference between being deep in debt and having a healthy portfolio. Changes to savings rates have some of the largest effects on outcomes of any decisions one can reasonably make. After that, top-line asset allocation (between stocks and fixed income, or between stocks/bonds/cash) based on goals and risk tolerance, is very important. Once one gets to the third level, investment selection, the decisions (30% international vs 35%) start having relatively smaller impacts. The main point at that level is to find an implementation, such as via the Three Fund Portfolio, and stay the course. Speculation, market timing, and panic selling are the things that are major risks once implementation has been decided on. One of the big behavioral benefits for some of having a small number of funds (if they use a three fund portfolio) is that they don't directly "see" things like value overperforming (or underperforming) growth - and may thus be less tempted to adjust the dials.

Anyway, this was just some of my feelings and opinions about this particular and very interesting suggestion. Debates regarding portfolios that happen to have three funds but aren't the Three Fund portfolio are probably best had in other threads, especially if they include asset classes not covered by the traditional Three Fund Portfolio. It is worth recognizing, though, that there are a lot of closely-aligned implementations (like Total World + Total Bond) that are very similar to versions of the regular Three Fund Portfolio.

Sure, a lot of people want to try to outperform the Three Fund portfolio. Everyone, though, should understand Taylor's portfolio, what it does, and why its assets are included before any consideration of more complex options. Why? I've noticed that on this site, Taylor's traditional Three Fund portfolio is the benchmark portfolio against which more complex portfolios are commonly compared to during backtesting. While history is no guarantee and there are limitations to backtesting, I've seen in backtests the substantial difficulty of beating the three fund portfolio on a fair, risk adjusted basis. It is very difficult to find a long-term,well diversified backtest that clearly beats The Three Fund Portfolio on a risk-ajusted basis and that has outperformance that can't be explained by luck alone. One's seemingly good ideas usually either underperform, underperform on a risk-adjusted basis, or overperform, but by a small amount such that it is questionable whether the possibility of that outperformance would be able to justify the hassle of the added complexity of more funds. Given that (at least around here) Taylor's traditional Three Fund portfolio is the benchmark portfolio against which all other portfolios are measured, wouldn't it be quite reasonable to own the benchmark?

When buying index funds, one owns the benchmark fund against which other funds are measured. When buying this three fund portfolio... one owns the the benchmark portfolio! Something to think about.

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Re: The Three-Fund Portfolio

Post by tucker99 » Wed Oct 25, 2017 10:07 am

Something not mentioned often is the dividend benefit of the 3-fund portfolio. Being semi-retired, I've changed from re-investing to having them sent to my checking account. Getting a nice sum every month and really nice sum every quarter.

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Re: The Three-Fund Portfolio

Post by PuddlesTheDuck » Wed Oct 25, 2017 1:49 pm

Thanks for the info TD2626. Some comments on what you said.
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
This is a three-fund portfolio, but it is not The Three Fund Portfolio as discussed in this thread. I do feel like your three-fund proposal would be reasonable for an investor tolerant of the currency and political risk that comes with a high international allocation, though.
I have one big issue with the strict adherence to the Three Fund Portfolio as presented at the start of this thread in 2012, and maybe I didn't explain myself well enough.
  • If you're following the Three Fund Portfolio, you have international stock. You have already admitted by doing this that there is something different worth owning internationally that won't come from US stocks alone, otherwise this would be the Two Fund Portfolio (or one fund if you use an instrument like VBIAX). Given international exposure is deemed beneficial, why don't we include international bonds?
Maybe the answer to this is simple: Vanguard didn't offer an international bond index fund until after this thread was started. You would then expect the thread to evolve and include talk of investing in international bonds. But that's not the case. From what I've seen (I haven't read the whole thread), there are two major complaints:
  • "Bonds are for safety", therefore we should only be investing in US treasuries or other highly rated US corporate bonds.
    • This is silly to me. Cash is for safety. Bonds are simply safer than stocks. And we've already established that there is some benefit to international diversification. You've already taken on the currency and political risks. Bonds are not fully safe, so why wouldn't you take advantage of the extra diversification?
  • Adding another fund adds complexity to the portfolio.
    • This is just laziness. The three fund portfolio was designed to make things simpler while still providing exposure to all the major asset classes. All of the bullets that Taylor laid out as reasons to use the Three Fund Portfolio in the original post still hold with international bonds. And to quote the Bogleheads wiki: "There is no magic in the number three; the phrase is shorthand for a style of portfolio construction that emphasizes simplicity, and is related to lazy portfolios."

      I'd also like to quote that the bond fund listed in the wiki is simply a 'bond "total market" index fund'. Sorry, but it's not the total market if you're not counting half the market.
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
It's probably best, though, to recognize that there's a hierarchy of investment decision importance. The most important decision is about the portfolio itself. Are you going to have a portfolio at all? Being prudent and frugal, and living below one's means, is the difference between being deep in debt and having a healthy portfolio. Changes to savings rates have some of the largest effects on outcomes of any decisions one can reasonably make. After that, top-line asset allocation (between stocks and fixed income, or between stocks/bonds/cash) based on goals and risk tolerance, is very important. Once one gets to the third level, investment selection, the decisions (30% international vs 35%) start having relatively smaller impacts. The main point at that level is to find an implementation, such as via the Three Fund Portfolio, and stay the course. Speculation, market timing, and panic selling are the things that are major risks once implementation has been decided on. One of the big behavioral benefits for some of having a small number of funds (if they use a three fund portfolio) is that they don't directly "see" things like value overperforming (or underperforming) growth - and may thus be less tempted to adjust the dials.
Agreed, and rather strongly. No matter what strategy you pick, you should HODL or risk missing out on all the benefits of your choices. But again, if you're already picking international stocks and taking on the associated risks, why not international bonds?
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
When buying index funds, one owns the benchmark fund against which other funds are measured. When buying this three fund portfolio... one owns the the benchmark portfolio! Something to think about.
Benchmarks that aren't good shouldn't be used, and this isn't a good benchmark. Why should the benchmark exclude more than half of the world bond market (Vanguard's Total Bond Index Fund notably doesn't include any high yield bonds, as well)? And then what version of the Three Fund Portfolio is the benchmark? What percentage international? What bond allocation? There is no single Three Fund Portfolio, so this benchmark is both incomplete and always moving. Example: http://www.marketwatch.com/lazyportfolio. The "Second Grader's Starter" is a Three Fund Portfolio, but it also has one of the highest stock allocations of all the other portfolios listed. These portfolios have totally different risk profiles but are still compared head-to-head. Moving benchmarks are bad benchmarks.

EDIT: I see you meant individual funds were the benchmark. Agree totally, but we still have the issue of missing a major portion of markets you're already invested in.

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Re: The Three-Fund Portfolio

Post by Taylor Larimore » Wed Oct 25, 2017 1:53 pm

TD2626 wrote:
Wed Oct 25, 2017 12:16 am
PuddlesTheDuck wrote:
Tue Oct 17, 2017 2:10 pm
I’ve read through a good part of this thread and some other ones and it seems Boglegeads have a serious aversion to international bonds, especially in this thread. If we believe in the value of diversification (which I hope we do) and believe in dicersification via international exposure (which I know some people don’t), why don’t we as a community believe in international bonds? Historically they have been both very stable (giving us the security that people seek in bonds) and very cheap (we have a vanguard index fund for them now).

It seems that the 3 fund portfolio for people who believe the above would be:

Total World Stock Index Fund (VTWSX)
Total US Bond Index Fund (VBTLX)
Total International Bond Index Fund (VTABX)

The only downside here is there aren’t admiral shares yet for the stock index. What do people think? Are we presenting ourselves with too much home country bias by only investing in US bonds?
This is a three-fund portfolio, but it is not The Three Fund Portfolio as discussed in this thread. I do feel like your three-fund proposal would be reasonable for an investor tolerant of the currency and political risk that comes with a high international allocation, though.

It's worth noting that this example is an example of one of a large number of very similar portfolios to The Three-Fund Portfolio that are roughly equivalent in spirit even though they don't use Vanguard Total Stock, Vanguard Total International Stock, and Vanguard Total Bond.

For example, investors who buy roughly equivalent index funds to Vanguard Total Stock, Vanguard Total International Stock, and Vanguard Total Bond managed by another fund company (like Fidelity, Schwab, or Blackrock) are reasonably likely to get very similar outcomes. Similarly, investors who do something like Total World + Total Bond or use a Vanguard Life Strategy or Vanguard Target Date fund are also doing things that are fairly similar to the three-fund philosophy. The options (including Vanguard LifeStrategy or Vanguard Target Date) that add international bonds, though. International bonds weren't originally envisioned in The Three Fund Portfolio, so there may be more of a difference in outcomes. I've even heard of Vanguard Total Stock + Vanguard Total World + Vanguard Total Bond three fund ideas suggested by posters that want to have an international allocation partly float with market cap while maintaining a home country bias.

Some people probably view the Three Fund Portfolio as a core element of a larger portfolio - it's used as a springboard to attach on other more exotic assets or tilts. While this could work for some, given that a core goal of the Three Fund Portfolio is simplicity, this may sort of be missing the point and defeating the purpose of the portfolio. Remember that the Three Fund Portfolio as proposed doesn't have specific suggested allocations. Investors have to determine their own ratios between the funds based on willingness, ability, and need to take risk.

It's probably best, though, to recognize that there's a hierarchy of investment decision importance. The most important decision is about the portfolio itself. Are you going to have a portfolio at all? Being prudent and frugal, and living below one's means, is the difference between being deep in debt and having a healthy portfolio. Changes to savings rates have some of the largest effects on outcomes of any decisions one can reasonably make. After that, top-line asset allocation (between stocks and fixed income, or between stocks/bonds/cash) based on goals and risk tolerance, is very important. Once one gets to the third level, investment selection, the decisions (30% international vs 35%) start having relatively smaller impacts. The main point at that level is to find an implementation, such as via the Three Fund Portfolio, and stay the course. Speculation, market timing, and panic selling are the things that are major risks once implementation has been decided on. One of the big behavioral benefits for some of having a small number of funds (if they use a three fund portfolio) is that they don't directly "see" things like value overperforming (or underperforming) growth - and may thus be less tempted to adjust the dials.

Anyway, this was just some of my feelings and opinions about this particular and very interesting suggestion. Debates regarding portfolios that happen to have three funds but aren't the Three Fund portfolio are probably best had in other threads, especially if they include asset classes not covered by the traditional Three Fund Portfolio. It is worth recognizing, though, that there are a lot of closely-aligned implementations (like Total World + Total Bond) that are very similar to versions of the regular Three Fund Portfolio.

Sure, a lot of people want to try to outperform the Three Fund portfolio. Everyone, though, should understand Taylor's portfolio, what it does, and why its assets are included before any consideration of more complex options. Why? I've noticed that on this site, Taylor's traditional Three Fund portfolio is the benchmark portfolio against which more complex portfolios are commonly compared to during backtesting. While history is no guarantee and there are limitations to backtesting, I've seen in backtests the substantial difficulty of beating the three fund portfolio on a fair, risk adjusted basis. It is very difficult to find a long-term,well diversified backtest that clearly beats The Three Fund Portfolio on a risk-ajusted basis and that has outperformance that can't be explained by luck alone. One's seemingly good ideas usually either underperform, underperform on a risk-adjusted basis, or overperform, but by a small amount such that it is questionable whether the possibility of that outperformance would be able to justify the hassle of the added complexity of more funds. Given that (at least around here) Taylor's traditional Three Fund portfolio is the benchmark portfolio against which all other portfolios are measured, wouldn't it be quite reasonable to own the benchmark?

When buying index funds, one owns the benchmark fund against which other funds are measured. When buying this three fund portfolio... one owns the the benchmark portfolio! Something to think about.
TD2626:

Thank you for your excellent analysis of The Three-Fund Portfolio.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: The Three-Fund Portfolio

Post by lostdog » Wed Oct 25, 2017 6:44 pm

PuddlesTheDuck wrote:
Wed Oct 25, 2017 1:49 pm
Thanks for the info TD2626. Some comments on what you said.
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
This is a three-fund portfolio, but it is not The Three Fund Portfolio as discussed in this thread. I do feel like your three-fund proposal would be reasonable for an investor tolerant of the currency and political risk that comes with a high international allocation, though.
I have one big issue with the strict adherence to the Three Fund Portfolio as presented at the start of this thread in 2012, and maybe I didn't explain myself well enough.
  • If you're following the Three Fund Portfolio, you have international stock. You have already admitted by doing this that there is something different worth owning internationally that won't come from US stocks alone, otherwise this would be the Two Fund Portfolio (or one fund if you use an instrument like VBIAX). Given international exposure is deemed beneficial, why don't we include international bonds?
Maybe the answer to this is simple: Vanguard didn't offer an international bond index fund until after this thread was started. You would then expect the thread to evolve and include talk of investing in international bonds. But that's not the case. From what I've seen (I haven't read the whole thread), there are two major complaints:
  • "Bonds are for safety", therefore we should only be investing in US treasuries or other highly rated US corporate bonds.
    • This is silly to me. Cash is for safety. Bonds are simply safer than stocks. And we've already established that there is some benefit to international diversification. You've already taken on the currency and political risks. Bonds are not fully safe, so why wouldn't you take advantage of the extra diversification?
  • Adding another fund adds complexity to the portfolio.
    • This is just laziness. The three fund portfolio was designed to make things simpler while still providing exposure to all the major asset classes. All of the bullets that Taylor laid out as reasons to use the Three Fund Portfolio in the original post still hold with international bonds. And to quote the Bogleheads wiki: "There is no magic in the number three; the phrase is shorthand for a style of portfolio construction that emphasizes simplicity, and is related to lazy portfolios."

      I'd also like to quote that the bond fund listed in the wiki is simply a 'bond "total market" index fund'. Sorry, but it's not the total market if you're not counting half the market.
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
It's probably best, though, to recognize that there's a hierarchy of investment decision importance. The most important decision is about the portfolio itself. Are you going to have a portfolio at all? Being prudent and frugal, and living below one's means, is the difference between being deep in debt and having a healthy portfolio. Changes to savings rates have some of the largest effects on outcomes of any decisions one can reasonably make. After that, top-line asset allocation (between stocks and fixed income, or between stocks/bonds/cash) based on goals and risk tolerance, is very important. Once one gets to the third level, investment selection, the decisions (30% international vs 35%) start having relatively smaller impacts. The main point at that level is to find an implementation, such as via the Three Fund Portfolio, and stay the course. Speculation, market timing, and panic selling are the things that are major risks once implementation has been decided on. One of the big behavioral benefits for some of having a small number of funds (if they use a three fund portfolio) is that they don't directly "see" things like value overperforming (or underperforming) growth - and may thus be less tempted to adjust the dials.
Agreed, and rather strongly. No matter what strategy you pick, you should HODL or risk missing out on all the benefits of your choices. But again, if you're already picking international stocks and taking on the associated risks, why not international bonds?
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
When buying index funds, one owns the benchmark fund against which other funds are measured. When buying this three fund portfolio... one owns the the benchmark portfolio! Something to think about.
Benchmarks that aren't good shouldn't be used, and this isn't a good benchmark. Why should the benchmark exclude more than half of the world bond market (Vanguard's Total Bond Index Fund notably doesn't include any high yield bonds, as well)? And then what version of the Three Fund Portfolio is the benchmark? What percentage international? What bond allocation? There is no single Three Fund Portfolio, so this benchmark is both incomplete and always moving. Example: http://www.marketwatch.com/lazyportfolio. The "Second Grader's Starter" is a Three Fund Portfolio, but it also has one of the highest stock allocations of all the other portfolios listed. These portfolios have totally different risk profiles but are still compared head-to-head. Moving benchmarks are bad benchmarks.

EDIT: I see you meant individual funds were the benchmark. Agree totally, but we still have the issue of missing a major portion of markets you're already invested in.
Hopefully Vanguard will come out with Total World Bond Index at some point.

Vanguard Total World Index
Vanguard Total World Bond Index

Talk about ultimate simplicity...
"Our life is frittered away by detail. Simplify, simplify." -Thoreau

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Adding international bonds?

Post by Taylor Larimore » Wed Oct 25, 2017 8:48 pm

The only downside here is there aren’t admiral shares yet for the stock index. What do people think? Are we presenting ourselves with too much home country bias by only investing in US bonds?
PuddlesTheDuck:

I answered your question in page 11 of this thread. It includes a statement by Mr. Bogle that he would not buy an international bond fund.

If you feel that adding an international bond fund is worthwhile, just add Vanguard's International Bond Index Fund but realize you are adding cost, complexity, and maybe risk because the 60% U.S. bonds and government mortgage-backed securities in Total Bond Market are among the safest in the world.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Adding international bonds?

Post by PuddlesTheDuck » Thu Oct 26, 2017 1:28 pm

Taylor Larimore wrote:
Wed Oct 25, 2017 8:48 pm
I answered your question in page 11 of this thread. It includes a statement by Mr. Bogle that he would not buy an international bond fund.
You certainly did and I hadn't read that post before, so thank you for that. For those who don't want to go back in time, here's the link to the post: viewtopic.php?f=10&t=88005&start=500#p1837043

But it still fails to answer the most fundamental questions about investing in international bonds: if we're ok with investing in international stocks, why are international bonds different?
Taylor Larimore wrote:
Fri Oct 25, 2013 5:02 pm
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.
One thing I'll always give you, Taylor, is that you always look at all your options thoroughly and have a pretty good sense of when it's worth your time to dig in and investigate.
Taylor Larimore wrote:
Fri Oct 25, 2013 5:02 pm
Vanguard's diversified Total Bond Market Index Fund has a proven record of providing safety in a portfolio. For example, during the 2008 bear market when Total Stock Market fell -37%, Total Bond market gained +5%.
This seems like a place to point out that past performance is not indicative of future results. This recession saw the US recover far faster than the rest of the world, and the rapid drop in interest rates help boost bond fund yields quite a bit. Why should that be true in the future? International bonds did alright during the crisis, too, so it's not like US bonds were particularly special here.
Taylor Larimore wrote:
Fri Oct 25, 2013 5:02 pm
Adding Total International Bond fund to The Three Fund Portfolio has several disadvantages: Political risk, higher expense ratios, longer duration, relatively week credit quality and more complexity.
I want to cover these in order, because I find this to be the most important part of your post:
  • Political risk
    • Is the political risk any different than the political risk faced by international stock? I legitimately don't know, but it feels like they should be the same. If they are the same, it begs the question: if you're ok with these issues in regards to international stocks, why not in regards international bonds?
  • Higher expense ratios
    • This would be a big deal if the expense ratios were any different than international stocks, but currently they are the same. I'd also argue that there's not a big difference between a 0.05% expense ratio (US Total Bond Admiral Shares) and a 0.12% expense ratio (Total International Bond Admiral Shares). Again, if you're ok with international stock, this doesn't seem like a real reason to avoid international bonds.
  • Longer duration
    • Yeah, this could certainly be an issue. Maybe for a "total bond" type of fund you'd want to bring the average duration to something less, but currently it's still sitting between 5 and 10 years for both US and international (6.1 and 7.7, respectively), so they both fall firmly in an intermediate term duration. I personally don't think there's any real difference there, but I see how people would be turned away by that. So a valid point and one I certainly hadn't considered before. I wonder why international bonds tend to be of a longer duration.
  • Relatively weak credit quality
    • I don't understand exactly why you're saying this. Because US government bonds are so highly rated, the US naturally has an advantage here. But Vanguard's strategy with their total bond index funds is to not hold bonds below a BAA rating. So while total international is missing out on bonds backed by the US government, it's certainly no slouch with regards to credit quality. I would personally argue that if you care so much about credit quality, you should invest only in US government bonds, but there is certainly some merit to your point.
Other than the longer duration issue you presented, I still don't see a compelling reason not to "own the world", if you will. It feels to me like the spirit of the Three Fund Portfolio demands "owning the world", and it's very strange to me how vocal people have been against owning international bonds. Maybe this is just a situation where people agree to disagree.

Thanks for the reply, Taylor, and thank you for all the work you've done!

Puddles

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Re: The Three-Fund Portfolio

Post by TD2626 » Thu Oct 26, 2017 4:24 pm

Taylor Larimore wrote:
Wed Oct 25, 2017 1:53 pm
TD2626:

Thank you for your excellent analysis of The Three-Fund Portfolio.

Best wishes.
Taylor
Thank you - and thank you for creating and writing the book on this benchmark portfolio!

PuddlesTheDuck wrote:
Wed Oct 25, 2017 1:49 pm
TD2626 wrote:
Wed Oct 25, 2017 12:16 am
When buying index funds, one owns the benchmark fund against which other funds are measured. When buying this three fund portfolio... one owns the the benchmark portfolio! Something to think about.
Benchmarks that aren't good shouldn't be used, and this isn't a good benchmark. Why should the benchmark exclude more than half of the world bond market (Vanguard's Total Bond Index Fund notably doesn't include any high yield bonds, as well)? And then what version of the Three Fund Portfolio is the benchmark? What percentage international? What bond allocation? There is no single Three Fund Portfolio, so this benchmark is both incomplete and always moving. Example: http://www.marketwatch.com/lazyportfolio. The "Second Grader's Starter" is a Three Fund Portfolio, but it also has one of the highest stock allocations of all the other portfolios listed. These portfolios have totally different risk profiles but are still compared head-to-head. Moving benchmarks are bad benchmarks.

EDIT: I see you meant individual funds were the benchmark. Agree totally, but we still have the issue of missing a major portion of markets you're already invested in.
Actually I was referring to the three-fund portfolio as a benchmark portfolio. In the Simba Spreadsheet and on PortfolioVisualizer, when backtesting a portfolio, one has the built in option to compare that portfolio to The Three Fund Portfolio. In the Simba Spreadsheet, the "Taylor Larimore Three Fund" portfolio is listed as 50% Total US, 30% Total International, and 20% Total US Bond. PortfolioVisualizer lists that same allocation as the "Bogleheads Three Funds" portfolio. (Interestingly, that allocation has 37.5% of equities in international. It's a 80/20 stock/bond portfolio as well, so it's higher risk than a traditional 60/40 benchmark portfolio. I wonder how that squares with Taylor's suggestion of 20% international.)

When backtesting funds, one would compare a fund (like a High Dividend Yield Fund) to a benchmark (like the S&P 500 Index). When backtesting portfolios, one would backtest a complex portfolio (like something with a variety of tilts) against a neutral benchmark portfolio (like The Three Fund Portfolio). Many who use index funds suggest the index funds because they want to "buy the benchmark fund". This portfolio being used as a benchmark suggests that it's something to consider for those wanting to buy the benchmark portfolio.

Remember the limits of backtesting. Past performance does not garuntee the future. In my opinion, Simba-style backtests are best if run over very long periods and if measuring risk-adjusted return. This post may help:viewtopic.php?t=137579#p2031980.

Oh - and regarding international bonds - Vanguard uses international bonds in its Life Strategy and Target Date funds - so using a Vanguard Four-Fund portfolio is quite reasonable. However, this thread's for the Larimore Three-Fund portfolio. Maybe if we want to discuss international bonds specifically a domestic vs international bond thread could be created. It seems like most of the domestic vs international threads tend to focus on domestic vs international stock.
lostdog wrote:
Wed Oct 25, 2017 6:44 pm
Hopefully Vanguard will come out with Total World Bond Index at some point.

Vanguard Total World Index
Vanguard Total World Bond Index

Talk about ultimate simplicity...
The ultimate simplicity in my opinion could be a balanced fund holding Total World Stock and Total World Bond index funds. However, maybe the fund could have deference to currency risk by adding a home country tilt (wait... this would be a LifeStrategy portfolio). Maybe it should be split up into separate stock and bonds funds though, so bonds can be held in tax-advantaged space (this would be a Vanguard Four-fund portfolio). Maybe the international bonds, given the heavy impact of currency risk and currency hedging costs, and the fact that they would otherwise be a small allocation in an equity dominated portfolio, could be dropped. Now you get to The Three Fund Portfolio.

Actually, what amazes me is that the ultimate in simplicity - Taylor's Three Fund Portfolio or any similar strategies that add international bonds or use Total World - actually represent in some respects, the ultimate in complexity as well - it's just that the complexity is rolled up into a small number of funds or even a single fund.

Look at Total Stock, for example. In an era when most individuals had diversified portfolios with a few dozen (at most) individual stocks, and when active mutual funds even today in general often have less than a few hundred stocks, having thousands is incredible portfolio complexity. Imagine trying to set out and assemble that complicated of a portfolio on your own with individual stocks - it would be impossible. Total Stock and Total International allow one to have a simple portfolio that actually has an incredible number of holdings "under the hood".

Remember, though, that complexity does not equal diversification. There are subtle differences. Many times, active fund strategies have fewer holdings (less diversity) under the hood yet due to their the multi-advisor, high turnover strategies employed they are far more complex than a buy-and-hold portfolio of all stocks on an index at cap weight.

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Re: The Three-Fund Portfolio

Post by David Scubadiver » Fri Oct 27, 2017 6:43 am

Then 3-Fund portfolio is a simple and efficient way to own the markets, with advantages over a total world investment, but at a slight increase in complexity.

Given that trading commissions are going to zero and given texhnilofy’s ability to efficiently allocate purchases and sales so as to keep a portfolio at its desired allocation, what do people think about breaking up the equities into small, mid and large, value and growth (in proportion to their weighting’s in VTI) and breaking up the VXUS into its components and letting technology do the allocations when desired?

I have not looked into the expense ratios of doing so or even what the components would be, but I see a potential benefit to proceeding this way—namely a much greater opportunity to Tax loss harvest by swapping out a vanguard low cost component that is underperforming with a low cost Schwab component. I would bet that you could harvest a loss 12 times a year easily.

(ETA: So I constructed Frank Armstrong’s “Ideal Index” using vanguard ETFS and the ER was .08%. That gives me an idea of what it costs to break down a 3 Fund plus REIT portfolio. I used 8 funds because I split international 50/40 into developed and emergong markets. That should probably be 80/20 developed/emerging)

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Re: The Three-Fund Portfolio

Post by Taylor Larimore » Fri Nov 03, 2017 2:02 pm

Given that trading commissions are going to zero and given texhnilofy’s ability to efficiently allocate purchases and sales so as to keep a portfolio at its desired allocation, what do people think about breaking up the equities into small, mid and large, value and growth (in proportion to their weighting’s in VTI) and breaking up the VXUS into its components and letting technology do the allocations when desired?
David,

I think it is a really bad idea to break-up a total market Three Fund Portfolio into its individual parts. It may make the advisor rich, but it will almost certainly add costs and complexity to the portfolio.

Please read my "Simplicity" link below.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: The Three-Fund Portfolio

Post by Veiled » Sun Nov 05, 2017 5:36 pm

This thread, especially the OP and its links, will take me several weeks to completely understand even though I'm already building this type of portfolio.

Right away, though, I have a question about rebalancing. I don't understand how this portfolio "automatically rebalances." Like everyone's portfolio in 2008, my equities decreased more than bond holdings and rebalancing required more money to stocks. 2008 is an exaggerated example, but a little drift happens every year. How can the three funds automatically rebalance when they behave so differently in response to market valuations and changes in interest rates?
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Re: The Three-Fund Portfolio

Post by David Scubadiver » Sun Nov 05, 2017 7:17 pm

Taylor Larimore wrote:
Fri Nov 03, 2017 2:02 pm
Given that trading commissions are going to zero and given texhnilofy’s ability to efficiently allocate purchases and sales so as to keep a portfolio at its desired allocation, what do people think about breaking up the equities into small, mid and large, value and growth (in proportion to their weighting’s in VTI) and breaking up the VXUS into its components and letting technology do the allocations when desired?
David,

I think it is a really bad idea to break-up a total market Three Fund Portfolio into its individual parts. It may make the advisor rich, but it will almost certainly add costs and complexity to the portfolio.

Please read my "Simplicity" link below.

Best wishes.
Taylor
Thanks, Taylor. My "Ideal Index" portfolio has an ER of .08 and isn't enriching any advisor, but clearly without FolioFN or M1 Finance it would be more troublesome to rebalance. And yest, both platforms charge a small fee. My post was more theoretical -- because, eventually, one will be able to automatically invest in fractional shares and rebalance at a cost of .01% (almost free) or free. But, you are correct for sure -- neither is "simplicity" and both lack the elegance of the 3 Fund portfolio. And, I am not even sure the increased tax loss harvesting opportunities make it worthwhile to hold the more complicated portfolio.

Because I am a tinkerer, I will run both portfolios. Neither of them will be "pure" because the one will have a NY muni fund in place of BND, and the other will have more Vanguard Value Fund than it ought, because I am already holding some and won't sell that until I have some losses to absorb the unrealized gains.

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Re: The Three-Fund Portfolio

Post by tj » Sun Nov 05, 2017 7:30 pm

Veiled wrote:
Sun Nov 05, 2017 5:36 pm
This thread, especially the OP and its links, will take me several weeks to completely understand even though I'm already building this type of portfolio.

Right away, though, I have a question about rebalancing. I don't understand how this portfolio "automatically rebalances." Like everyone's portfolio in 2008, my equities decreased more than bond holdings and rebalancing required more money to stocks. 2008 is an exaggerated example, but a little drift happens every year. How can the three funds automatically rebalance when they behave so differently in response to market valuations and changes in interest rates?
It doesn't. You'd need to use a fund that has all of the components in the percentage that you want. If you don't want international bonds, then FFNOX comes to mind:

https://fundresearch.fidelity.com/mutua ... /31634R109


If you don't mind the international bonds, then Vanguard Target Date or LifeStrategy funds would work.

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Re: The Three-Fund Portfolio

Post by CABob » Sun Nov 05, 2017 7:32 pm

Veiled wrote:
Sun Nov 05, 2017 5:36 pm
Right away, though, I have a question about rebalancing. I don't understand how this portfolio "automatically rebalances." Like everyone's portfolio in 2008, my equities decreased more than bond holdings and rebalancing required more money to stocks. 2008 is an exaggerated example, but a little drift happens every year. How can the three funds automatically rebalance when they behave so differently in response to market valuations and changes in interest rates?
This portfolio does not automatically rebalance so I'm not sure what you read that gave you that impression. With only three funds, however, it is relatively easy to keep it balanced which can be done with what you choose to do with dividends, new contributions, withdrawals, etc. You still may have to do some exchanging between funds to keep them in balance.
Bob

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Rebalancing

Post by Taylor Larimore » Sun Nov 05, 2017 8:58 pm

Veiled wrote:
Sun Nov 05, 2017 5:36 pm
How can the three funds automatically rebalance when they behave so differently in response to market valuations and changes in interest rates?
Veiled:

In the opening post I wrote about the benefit of "Automatic rebalancing within each fund."

We still must rebalance each of the three funds to maintain our desired asset-allocation. However, total market Index funds generally have less volatility than the smaller asset-classes within them.

Rebalancing The Three-Fund Portfolio is much easier than trying to rebalance more funds more often.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Rebalancing

Post by Veiled » Mon Nov 06, 2017 8:13 am

Taylor Larimore wrote:
Sun Nov 05, 2017 8:58 pm
Veiled:
In the opening post I wrote about the benefit of "Automatic rebalancing within each fund."

We still must rebalance each of the three funds to maintain our desired asset-allocation. However, total market Index funds generally have less volatility than the smaller asset-classes within them.

Rebalancing The Three-Fund Portfolio is much easier than trying to rebalance more funds more often.

Best wishes.
Taylor
Thank you. As I was reading last night I realized that the OP says this and the link explains it well. I appreciate you taking the time to explain, and same to tj and CABob.
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Re: The Three-Fund Portfolio

Post by olivertwist » Fri Nov 10, 2017 10:08 am

lostdog wrote:
Wed Oct 25, 2017 6:44 pm
Hopefully Vanguard will come out with Total World Bond Index at some point.

Vanguard Total World Index
Vanguard Total World Bond Index

Talk about ultimate simplicity...
However, some investors will have an aversion to the prescribed domestic:international mix in either the total world stock or total world bond portfolios, preferring a home-country bias or another ratio than is offered by the fund. Granted, the fund managers at Vanguard are likely smarter than the average investor, but this does not necessarily correlate with success. This is why, given the expense ratios being similar, I think utilizing a different two-, three-, or four-fund portfolio can still be ideal for a lot of folks, as you can maintain the virtues of diversification and index investing without being tied to an international investment that you may not have the stomach for. (e.g. you could cheaply mix VTI+BND+VXUS+BNDX or their mutual fund equivalent depending on your personal willingness for international exposure).

Also, as you wrap everything up (e.g. into a two-fund portfolio or a Target Retirement fund) you lose some of your ability to allocate tax-efficiently. It would be easy enough to just toss your 10% bond investment into your IRA and 401k and fill remaining room with the stock index, spilling over into a taxable account if necessary. But you lose the ability to more discretely allocate investments based on income.

Personally, I think that as a basis for a long-term portfolio, a two-fund global stock and global bond base would still be strong, but I could see where some would balk at it a bit.

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Re: The Three-Fund Portfolio

Post by LadyGeek » Sun Nov 19, 2017 7:30 pm

New member Road2Freedom has a question which I've moved into a stand-alone thread. See: [Switching from Target Date fund to 3-fund portfolio - How?]
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