The Three-Fund Portfolio

Mrs.Feeley · Post by **Mrs.Feeley** » Tue Jan 03, 2012 12:09 am

rohitj wrote:You still have institutional risk. If vanguard screws up their algorithms for buying / selling / balancing, you're pretty much screwed. Just not worth the risk to me -- I'd rather have 8 or 10 funds spread between 2 or 3 trusted institutions.

This is a really good point. After lots of reading and discussion my husband and I decided to move toward a three-fund portfolio with Vanguard's VTIAX, VBTLX, and VTSAX at the core. But we both have concerns about investing all of our retirement savings with Vanguard. "Bogle has another heart attack and who knows but everyone left at Vanguard may turn into the next Bernie Madoff!" my better half likes to warn.

So we're thinking about spreading things among the index funds at Schwab and Fidelity. There's been some discussion about that here on Bogleheads, and consensus seems to be that most don't think there's enough of a risk to warrant using multiple fund families. But we've not yet been able to come to a decision about this.

umfundi · Post by **umfundi** » Tue Jan 03, 2012 12:28 am

Mrs.Feeley wrote:
rohitj wrote:You still have institutional risk. If vanguard screws up their algorithms for buying / selling / balancing, you're pretty much screwed. Just not worth the risk to me -- I'd rather have 8 or 10 funds spread between 2 or 3 trusted institutions.

This is a really good point. After lots of reading and discussion my husband and I decided to move toward a three-fund portfolio with Vanguard's VTIAX, VBTLX, and VTSAX at the core. But we both have concerns about investing all of our retirement savings with Vanguard. "Bogle has another heart attack and who knows but everyone left at Vanguard may turn into the next Bernie Madoff!" my better half likes to warn. So we're thinking about spreading things among the index funds at Schwab and Fidelity. There's been some discussion about that here on Bogleheads, and consensus seems to be that most don't think there's enough of a risk to warrant using multiple fund families. But we've not yet been able to come to a decision about this.

Yes.

Everyone needs a monster under the bed theory to help justify their investment quirks.

Keith

stlutz · Post by **stlutz** » Tue Jan 03, 2012 12:34 am

There's been some discussion about that here on Bogleheads, and consensus seems to be that most don't think there's enough of a risk to warrant using multiple fund families.

The problem with using multiple fund families is that you increase you exposure to the type of risk you are concerned about. Instead of only worrying about Vanguard, you now have to worry about Vanguard, Fidelity, and Schwab.

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 8:17 am

Hi Rob:

I will try to answer your questions:

Total International? Doesn't the FTSE outperform this, as well as including otherwise-missing Canada?

Total International (VGTSX) and FTSE All-World Ex-US (VFWIX) are very similar although VGTSX holds many more stocks and has a lower Expense Ratio. Both funds include Canadian stocks. Regarding past performance, this is what two experts say:

Jack Bogle: "In selecting equity funds, no analysis of the past, no matter how painstaking, assures future superiority."

David Swensen, Yale's Chief Investment Officer: "Chasing performance is the biggest mistake investors make. If anything, it is a perverse indicator."

Total Bond Market? Isn't the IT bond Market both safer and preferred by Jack Bogle?

In his "Little Book of Common Sense Investing," Mr. Bogle recommends Vanguard's diversified Total Bond Market Index Fund.

And what about a safe house for money? How about the ST Bond Market?

Any of Vanguards Short-Term Bond Funds should be a "safe house" for money. A good rule for bonds and bond funds: "The higher the yield, the higher the risk."

Best wishes:
Taylor

DartThrower · Post by **DartThrower** » Tue Jan 03, 2012 10:46 am

Hi Taylor.

Your post is probably the best advice we'll get all year, and it's only January 3rd!

Over the past 10 years I have been gradually moving toward the 3-fund style of investing as you have spelled it out.

The one slight deviation I have been tempted to make lately is to buy a 5 year FDIC insured CD with some of my ST bond money. If rates go up sharply, cash in the CD, pay the penalty and reinvest elsewhere. A side benefit of doing this would be that the money would be with a solid bank and not Vanguard. This would address the concerns expressed in another post about having all one's eggs in the Vanguard basket. Any thoughts?

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 11:13 am

DartThrower wrote:Hi Taylor.

Your post is probably the best advice we'll get all year, and it's only January 3rd!

Over the past 10 years I have been gradually moving toward the 3-fund style of investing as you have spelled it out.

The one slight deviation I have been tempted to make lately is to buy a 5 year FDIC insured CD with some of my ST bond money. If rates go up sharply, cash in the CD, pay the penalty and reinvest elsewhere. A side benefit of doing this would be that the money would be with a solid bank and not Vanguard. This would address the concerns expressed in another post about having all one's eggs in the Vanguard basket. Any thoughts?

DartThrower:

There is more than one road to Dublin.

Best wishes.
Taylor

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 12:22 pm

Hi Keith:

Is there someone in particular at Vanguard that we should thank for continuing and expanding Jack Bogle's vision?

I am not privy to what goes on within Vanguard. I believe, however, that Mr. Bogle's decision to structure Vanguard as the only mutual fund company owned by it's investors has helped to continue Jack's vision: "To give ordinary investors a fair shake."

Best wishes.
Taylor

555 · Post by **555** » Tue Jan 03, 2012 12:40 pm

AnotherINTP wrote:(Constant rebalancing is just constantly buying low and selling high, right? )

No. Not necessarily.

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 12:52 pm

Mrs.Feeley wrote: We're thinking about spreading things among the index funds at Schwab and Fidelity. There's been some discussion about that here on Bogleheads, and consensus seems to be that most don't think there's enough of a risk to warrant using multiple fund families. But we've not yet been able to come to a decision about this.

Mrs. Feeley:

I had the same apprehensions when we decided to leave Merrill Lynch and move all our investments to Vanguard in 1986. This is what I learned:

Vanguard Safety? Our WIKI has a discussion of this subject here: Vanguard Safety

Why consolidate all investments at Vanguard?

1. One familiar statement.

2. Less paperwork.

3. Easier tax preparation.

4. Avoidance of low-balance and other small fees.

5. It's much easier to learn only one company's policies, fees, regulations, etc.

6. With larger holdings it may be possible to qualify for lower costs and premium services (Voyager, Admiral, Flagship).

7. Rebalancing and exchanges are easier.

8. Eliminates 3rd party brokerage.

9. A loyal customer is appreciated and usually treated better.

10. Less chance of errors.

11. The knowledge that Vanguard's fine reputation and low-costs are always working for us: Vanguard Fund Performance

12. More free time for ourselves.

13. In event of death or disability, it will be much easier for others to only deal with one company.

Best wishes.
Taylor

Alf 101 · Post by **Alf 101** » Tue Jan 03, 2012 2:43 pm

I'd also like to add my thanks for this post, and for the great help and advice I've received from this site, and from many excellent books in the Boglehead library. It is fortunate I stumbled on this in my 20s and could set the course, then stay the course, with something so simple.

One interesting thing I just realized concerns the Total International fund. When I started the TISM was a fund of funds and did not include emerging market. What I did instead was to hold three international funds in my Roth: European, Pacific, and Emerging Markets -- thus creating my own Total Int'l Stock Mkt fund. I believe at the time, particularly upon reaching the Admiral fund levels, the expense ratios would also be less.

Things have changed quite a bit since then with the TISM. Most interesting to me are the number of stocks these different stocks hold:

European Stock Index (VEURX): 476
Pacific Stock Index (VPACX): 469
Emerging Markets (VEIEX): 917

Sum of all 3: 1862
Total Int'l Stock Index (VGTSX): 6700

So I thought I could use these 3 funds to create my own "Total International" but in doing so gives me a holding with 4838 fewer stocks. Thus it does not seem that what I have in my Roth right now is as diversified. However, as regards costs, admiral TISM has an ER of 0.20%. The admiral classes of European and Pacific have a 0.14% ER, whereas admiral Emerging Markets is 0.22%. So I would need to pay a little more for greater diversification. Part of why I like the Total Stock Market so much, besides its excellent diversification, is that it has lower costs than almost all the other equity funds.

So an interesting decision for me. Acknowledging the great appeal of simplicity, do you roll the three international funds into TISM, or leave them as they are? Again, I didn't choose these three because I wanted to overweight any particular region, just to create a cheaper TISM. Hmm...

FrugalInvestor · Post by **FrugalInvestor** » Tue Jan 03, 2012 2:50 pm

I agree with you Taylor. One can always do a little fiddling around the edges (which I do) to demonstrate that we are smarter than the average Boglehead :wink:

but I think it's difficult to go wrong with the three fund solution. I've also learned that it can make one's life much simpler when it comes to rebalancing, portfolio tracking and taxes.

Thank you Taylor for nudging me in this direction a few years ago. :sharebeer

lazyfabs · Post by **lazyfabs** » Tue Jan 03, 2012 3:25 pm

Taylor,

Thanks for the great post and to all for the wonderful follow up.

Since the LifeStrategy funds have adopted the 3 fund approach, do you (or anyone that want to chime in) feel like the % they have allocated to each fund is appropriate?

Ex: mod growth having an approximate 40% TSM, 30% TISM, 40% TBM should be 50/20/40 or some other combination w/in the designated parameters. This would be for the other LS funds.

Thanks

Rodc · Post by **Rodc** » Tue Jan 03, 2012 4:42 pm

Muchtolearn wrote:
FNK wrote:
Muchtolearn wrote:US stocks now have half their earnings abroad and probably international stocks have half their earnings here. So it may be all a wash. At least I'm going that way.

Folks, this is a fallacy. You're confusing the market of a corporation with the ownership of a corporation. Consider:

Apple (a US corporation) sells iPhones. Samsung and HTC (Asian corporations) sell Android phones.

Suppose you own only US companies. Suppose Android kills iPhone. How is it relevant to your portfolio that Apple sells iPhones in Europe?

The fact that US companies operate internationally means that the owner of US stocks is exposed to international risks. The fact that foreign companies operate in US means the same. The boglehead response to risk is to diversify. Not owning international companies means taking uncompensated risk, i.e. leaving free lunch on the table.

Note that US companies operating world-wide also expose you to currency risks, so the currency home bias is questionable.

And that's why I like 50/50 us/intl equity. A simple approximation to true market weighting (and a little bit of cowardice, I may be wrong after all). TR's 70/30 is backwards looking.

International stocks are on sale now, load up.

FNK,
Let's assume, as I think you agree, but even if you don't agree, that precisely half of US earnings are international and vice versa. Please explain why it would then matter if you were invested 50% each or 100% in US or 100% international? To go further, what if you lived in the UK? Would you be half UK and half international?

Why would you only buy Chevy and Ford and skip Honda and Toyota, if you can buy all very cheaply?

Your logic is like saying only buy every other company in TSM. Yeah, probably no real harm, but why would you?

Own the market. If you want less currency risk, and your home market is well diversified in its own right you could tilt a little towards home (ie in the US you might hold a little more US than non-US. In the UK a slight tilt would look very different as UK is a much smaller market and less diversified).

clevername · Post by **clevername** » Tue Jan 03, 2012 6:17 pm

Taylor Larimore wrote:
Vanguard Safety? Our WIKI has a discussion of this subject here: Vanguard Safety

Best wishes.
Taylor

Hi Taylor,

Thanks for the insight as always. I read the link you posted above and have a quick question I'd like to throw out there (maybe not so quick!). Allow me to quote the wiki:

Vanguard (and every other US-regulated mutual fund company) must custody their assets with a third party. All of the funds managed by Vanguard have their assets held with JPMorgan Chase. JPMorgan is audited by PriceWaterhouseCoopers[2], which provides additional, independent verification that Vanguard's funds hold what they're supposed to.

I am curious: what happens to our assets at Vanguard if, and I stress IF, PriceWaterhouseCoopers is full of accountants with the same standards as those employed by Arthur Anderson, the Big 5 firm largely responsible for the failure to properly audit Enron? As far as I know, Arthur Anderson accountants were complicit in covering up Enron's imminent bankruptcy and we all know what happened there. I'm not worried about Vanguard going broke; near as I can tell the weakest link in the chain is relying on PWC to make sure JP Morgan actually has the assets Vanguard says they have. There's a lot of if's here - IF JP Morgan loses/embezzles the money and IF PWC doesn't report it...but could it happen?

It's difficult to imagine, but who could have predicted Enron? Or Bernie Madoff or Lehman filing for bankruptcy etc.

Thanks!

umfundi · Post by **umfundi** » Tue Jan 03, 2012 6:59 pm

Taylor,

You have a convert. I have decided to switch from the Gone Fishin' Portfolio to 35% Total Stock, 25% Total International Stock, and 40 % Total Bond. I'll probably do the same for my two pre-college sons, whose UGMs and 529s I manage.

In coming to this decision I did have to sit myself down and give myself a couple of stern Boglehead lectures. (Why not 5% TIPS, why not 5% Natural Resources, why not ... ?)

By the way, by my estimate the Gone Fishin' Portfolio lost 3% last year, because it has 10 % each in Europe, Pacific, and Emerging Markets. http://www.gonefishinportfolio.com/

There's nothing particularly wrong with it (in my opinion), but it is complicated and could be modernized for the Vanguard changes since 2002. Alex Green taught me a lot.

Thank you for simplifying my life, and contributing to my understanding. May we call it the Taylor Larimore Three Fund, TLTF Portfolio?

Best wishes,

Keith

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 8:02 pm

Hi Keith:

Thank you for simplifying my life, and contributing to my understanding. May we call it the Taylor Larimore Three Fund, TLTF Portfolio?

Let's call it a Bogle Portfolio because it contains his best teachings.

Now, when you get to be my age (87), you will not be stuck with dozen's of unwanted securities because selling or exchanging them (in taxable accounts) will trigger capital gains. Perhaps most important of all, you will appreciate the importance of owning a simple portfolio that you, your caregivers, and your heirs can easily understand and maintain.

Congratulations and many Happy New Year's!

Taylor

SGM · Post by **SGM** » Tue Jan 03, 2012 8:33 pm

I moved Vanguard European, Asian and Emerging markets into Vanguard Total International Fund for tax loss harvesting. Bernstein's Four Pillars (2010) recommends against keeping Vanguard Total International Fund in a taxable account because it is a "fund of funds" and is not eligble for foreign dividend tax exclusion. Is that still the case and can I not deduct the foreign dividends on my income tax?

I admire Taylor's simplification. I am slowly moving in that direction. I've got a wild hair though.

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 03, 2012 8:41 pm

SGM:

Vanguard has consolidated the three original funds in Total International. You can now benefit from the foreign tax credit on your income tax return.

Best wishes.
Taylor

SobeCane · Post by **SobeCane** » Tue Jan 03, 2012 8:48 pm

clevername wrote:
Hi Taylor,

Thanks for the insight as always. I read the link you posted above and have a quick question I'd like to throw out there (maybe not so quick!). Allow me to quote the wiki:

Vanguard (and every other US-regulated mutual fund company) must custody their assets with a third party. All of the funds managed by Vanguard have their assets held with JPMorgan Chase. JPMorgan is audited by PriceWaterhouseCoopers[2], which provides additional, independent verification that Vanguard's funds hold what they're supposed to.

I am curious: what happens to our assets at Vanguard if, and I stress IF, PriceWaterhouseCoopers is full of accountants with the same standards as those employed by Arthur Anderson, the Big 5 firm largely responsible for the failure to properly audit Enron? As far as I know, Arthur Anderson accountants were complicit in covering up Enron's imminent bankruptcy and we all know what happened there. I'm not worried about Vanguard going broke; near as I can tell the weakest link in the chain is relying on PWC to make sure JP Morgan actually has the assets Vanguard says they have. There's a lot of if's here - IF JP Morgan loses/embezzles the money and IF PWC doesn't report it...but could it happen?

I was also wondering about this...can anyone shed some light?

umfundi · Post by **umfundi** » Tue Jan 03, 2012 9:30 pm

I was also wondering about this...can anyone shed some light?

Maybe Vanguard is too big to fail? :wink:

Keith

BostonBoy · Post by **BostonBoy** » Tue Jan 03, 2012 9:36 pm

stlutz wrote:My 2012 prediction. Taylor's original post will be the best post on this board for the entire year.

+1

looking · Post by **looking** » Tue Jan 03, 2012 11:01 pm

nothing for granted---all the the time " due diligent"
there can be a unthinkable things can be happen _-

Valuethinker · Post by **Valuethinker** » Wed Jan 04, 2012 8:21 am

Taylor Larimore wrote:Bogleheads:

After a lifetime of investing since 1950 trying to "beat the market," I am convinced that a simple 3-fund (or ETF) portfolio of Total Stock Market, Total International, and Total Bond Market, properly balanced, is an ideal portfolio for most investors. The advantages are many:

* Maximum diversification with over 10,000 worldwide securities (lower risk).
* No worry about under-performing the index.
* Very low-cost (including hidden transaction costs).
* Very high tax-efficiency (converts tax-inefficient stocks to tax-efficient stocks).
* No manager risk.
* No style drift.
* No sub-index "front-running."
* Simple to understand and maintain.
* More time with family and friends.
* High probability of outperforming most funds. Morningstar's 15-year Category Performance (12-31-2011):

Happy New Year!

Taylor

Taylor

I most heartily agree.

However the one factor you are not fully diversified against is inflation.

I think the investor should also hold a decent slug of TIPS. I would say towards half of all bond portfolios (or 20-30% of total portfolio). In addition, one should consider I Bonds and CDs when these are attractive. Ditto municipal bonds. (ie when tax considerations and after tax yields make them attractive).

*however* at current TIPS yields that's a distraction. History says they will be available at higher real yields, in the future. At negative real yields, the investor is paying a fairly high price for inflation protection right now (at least relative to historic).

Non Usians need to have much higher weightings in global cap weighted equity portfolios. On a hypothetical 50/50 portfolio that 50%in equities should be globally cap weighted (bonds are much more likely to be domestic *providing* there is not a Euro-Greece/Portugal/Italy style risk of default).

In an ideal world, one would have access to TIAA RE Annuity for up to 10% of one's assets (tradeoff against inflation protected bonds). However this is not an ideal world, and very few here would have access to a relatively 'pure' (but diversified, and well managed) Commercial RE portfolio. Indeed looking at the inflows and outflows from that fund, the problem of open ended funds in illiquid assets (that the purchase and sale of units hurts those who stay in the fund) remains- -TIAA has taken steps to limit that liquidity in the future, but it is still a risk for investors.

Valuethinker · Post by **Valuethinker** » Wed Jan 04, 2012 8:29 am

umfundi wrote:
I was also wondering about this...can anyone shed some light?

Maybe Vanguard is too big to fail?

Keith

No the Investment Companies Act of 1940 provides a much greater guarantee.

The assets of a US mutual fund are held by a separate custodian. If the manager (Vanguard) fails, then the assets are clearly and separately segregated.
That's been tested again and again in various scenarios with asset managers getting into financial distress and even bankruptcy.

The big fund manager frauds are outright: Madoff and Bernie Cornfeld/ IOS before them. Ie where the money never actually got into the segregated accounts.

So a default by Vanguard would not eliminate the client assets. The whole structure of custody banks, trustees with fiduciary duty, etc., mitigate against that risk. Note the custodian banks would have different auditors!

You'd have to postulate an all out fraud that included rigging the computer systems so fictitious assets were created and valuations given (yet somehow matched the custodian computers ie outside VG). That would require a large conspiracy (to say the least)-- not just the management and internal audit of VG, but also in the custody banks, IT departments etc. Madoff managed it by keeping the conspiracy down to 5 people + a couple of auditors at a tiny audit firm, and fixing a 30 year old computer system to give false valuations.

Something like that did happen with Teamster Union pension fund money, but that was with heavy mafia involvement. Cash literally being lifted out of desk drawers. Most VG mutual fund holders don't pay cash for their units ;-)

.

The analogy to Enron (or Worldcom or even Lehman) is inexact and false-- they were dealing on their own balance sheet.

To the extent VG is a broker, like Lehman or MF, then there could be a question of assets not being separately segregated.

If you want to worry about Vanguard worry more about counterparty risk. Since it's one of the biggest investors, it therefore has one of the biggest counterparty exposures, if a major player, a Goldman or a Morgan Stanley, or a major clearninghouse or Stock Exchange went broke.

Valuethinker · Post by **Valuethinker** » Wed Jan 04, 2012 8:31 am

SobeCane wrote:
clevername wrote:
Hi Taylor,

Thanks for the insight as always. I read the link you posted above and have a quick question I'd like to throw out there (maybe not so quick!). Allow me to quote the wiki:

Vanguard (and every other US-regulated mutual fund company) must custody their assets with a third party. All of the funds managed by Vanguard have their assets held with JPMorgan Chase. JPMorgan is audited by PriceWaterhouseCoopers[2], which provides additional, independent verification that Vanguard's funds hold what they're supposed to.

I am curious: what happens to our assets at Vanguard if, and I stress IF, PriceWaterhouseCoopers is full of accountants with the same standards as those employed by Arthur Anderson, the Big 5 firm largely responsible for the failure to properly audit Enron? As far as I know, Arthur Anderson accountants were complicit in covering up Enron's imminent bankruptcy and we all know what happened there. I'm not worried about Vanguard going broke; near as I can tell the weakest link in the chain is relying on PWC to make sure JP Morgan actually has the assets Vanguard says they have. There's a lot of if's here - IF JP Morgan loses/embezzles the money and IF PWC doesn't report it...but could it happen?

I was also wondering about this...can anyone shed some light?

Hi I have just posted an answer above.

The Investment Companies Act of (1940?) mandates separate custodian. The assets of the fund are held by a financial institution different than Vanguard, and there has to be a reconciliation of what the custodian bank (like State Street, or JP Morgan) thinks the fund owns, vs. what VG's computer systems say it owns (which assets and which shares).

englishgirl · Post by **englishgirl** » Wed Jan 04, 2012 9:01 am

lazyfabs wrote:Taylor,

Thanks for the great post and to all for the wonderful follow up.

Since the LifeStrategy funds have adopted the 3 fund approach, do you (or anyone that want to chime in) feel like the % they have allocated to each fund is appropriate?

Ex: mod growth having an approximate 40% TSM, 30% TISM, 40% TBM should be 50/20/40 or some other combination w/in the designated parameters. This would be for the other LS funds.

Thanks

I feel like the percentage allocated to each fund is fine. Is it what I personally would pick? Not necessarily. But can I work with it? Sure.

When I roll over my 401k (hopefully this year), I have decided to go with LS moderate growth. It doesn't have as much international as I'd want, but I have an old UK pension account that I can't move easily, and that is already invested in an international index. So actually, I'll end up with more international than I want when viewed as a whole. But that's OK too. I didn't pick my preferred international/US percentages by any scientific means, so it doesn't matter to me any more if I'm 10-20% off on either side. Just so long as I keep life simple, I find that it's more than good enough for me.

Taylor Larimore · Post by **Taylor Larimore** » Wed Jan 04, 2012 10:44 am

lazyfabs wrote:Taylor,

Thanks for the great post and to all for the wonderful follow up.

Since the LifeStrategy funds have adopted the 3 fund approach, do you (or anyone that want to chime in) feel like the % they have allocated to each fund is appropriate?

Ex: mod growth having an approximate 40% TSM, 30% TISM, 40% TBM should be 50/20/40 or some other combination w/in the designated parameters. This would be for the other LS funds.

Thanks

Hi lazyfabs:

The stock/bond ratio in our portfolo is the most important factor for determining our expected risk and expected return. For example, in the next bear market we should expect our portfolio to decline about half our stock allocation (or even more).

Both the portfolios you mention have the same 70% stock allocation so I would expect both portfolios to perform about the same over longer periods. Sub-allocations are much less important. Also, it is impossible to predict a fund's future performance. In my opinion, seeking precision in future returns is a waste of time.

I am confident that Vanguard experts spent a good deal of time and research designing their Target and Life Strategy funds. I am also pleased to see that these experts were not afraid to change the funds when newer funds and addtional research suggested improvement.

I lack the self-assurance to imagine that I can design a better portfolio than Vanguard experts--except to adjust our portfolio to our own personal situation.

We must also remember that the stock/bond ratio in both the Target and Life Strategy funds is easily changed in tax-deferred accounts (where these fund-of-funds usually belong).

Best wishes.
Taylor

sdrone · Post by **sdrone** » Wed Jan 04, 2012 4:49 pm

If you're worried about the "Vanguard" risk of investing in one or more of their mutual funds, then simply invest in their ETFs. The ETFs are the same investment, and when an ETF liquidates, you simply get the stocks that the ETF owned.

Posts like this always make me look back at what I'm doing, which is a very good thing. If I use BND, VTI, and VEU at a 40%/30%/30% ratio, it's a pretty interesting comparison. My hybrid Swedroe/Merriman portfolio won by a smidge in 2009 and 2010, but lost significantly in 2008 (which is a year I ALWAYS look at - I want to know what happens in a "black swan" year.

Interesting stuff. Like they always say, simple is often better.

Valuethinker · Post by **Valuethinker** » Thu Jan 05, 2012 5:11 am

sdrone wrote:If you're worried about the "Vanguard" risk of investing in one or more of their mutual funds, then simply invest in their ETFs. The ETFs are the same investment, and when an ETF liquidates, you simply get the stocks that the ETF owned.

Posts like this always make me look back at what I'm doing, which is a very good thing. If I use BND, VTI, and VEU at a 40%/30%/30% ratio, it's a pretty interesting comparison. My hybrid Swedroe/Merriman portfolio won by a smidge in 2009 and 2010, but lost significantly in 2008 (which is a year I ALWAYS look at - I want to know what happens in a "black swan" year.

Interesting stuff. Like they always say, simple is often better.

I don't know much about the structure and risks of ETFs BUT:

- some ETFs use swaps not actual physical holdings - this raises counterparty risk

- ETFs are more 'liquidizable' - my intuition is that in the rush for the exit, VG mutual fund money would prove to be 'stickier'. Since exits from a fund disadvantage remaining holders (the discount as the fund manager sells holdings is absorbed by all unit holders) in a meltdown the stickier fund will perform better

- I am comfortable that an organization like Vanguard, operating an investment forum proven since the 1940 Act, is about as safe a place for a client's money as can be imagined.

ETFs are newer, and I am just less confident about the 'stress testing' of the product.

To reiterate, the assets of Vanguard TSM are held by a separate custodian. Material fraud would be difficult AFAIK. Similarly if VG became insolvent, then the assets would be transferred to a new manager. Clients would potentially only lose their cash deposits with Vanguard (for all I know, they may be held by a separate banking institution).

Mutual Funds have stood the test of time. ETFs are good, but should be used where very low cost mutual funds run by people like Vanguard are just not available due to account restrictions/ tax/ asset type etc.

PonchoPKA · Post by **PonchoPKA** » Thu Jan 05, 2012 9:22 am

Quick question that may have already been answered...

I have traditionally for the past 10+ years been a consistent "slice and dice" but due to issues with managing two 401K/403b, 2 Roth and 2 Rollover IRA this approach has become "difficult". I am thinking of moving towards the "three fund" method to simplify my life.

The biggest issue it that in both of our 401K/403bs there is no "total market" option. Only an SP500 index with an actively managed SC/SV option (possibly a MC).

What mix of SP500/SC would you recommend to "simulate" Total Stock market? I from my research it looks like an 80/20 split would be best...

Thanks!
Poncho (a looooong time lurker)

Taylor Larimore · Post by **Taylor Larimore** » Thu Jan 05, 2012 10:33 am

Hi Poncho:

Welcome to the Bogleheads Forum!

I hope that you are looking at your portfolio as a whole--not just individual accounts.

In my opinion, adding 20%-30% of Small-Cap or Mid-Cap to the S&P 500 Index Fund is a reasonable ratio. No one can predict future returns so don't worry about exactness.

Best wishes
Taylor

sdrone · Post by **sdrone** » Thu Jan 05, 2012 10:53 am

the ETFs we're talking about (VTI, etc.) hold stocks.

The "wind down" of ETFs has already been tested several times, and has "worked as expected."

There are times when I'm far more comfortable being able to sell my holdings during the day rather than waiting to be stuck with the end of the day closing price.

It can be a philosophical discussion, of course, but the safety of the structure really isn't a question.

cid64 · Post by **cid64** » Thu Jan 05, 2012 2:41 pm

What would be recommended as a substitute for Total Bond in the Three Fund Portfolio if money has to be invested in a taxable account? I would lean towards Intermediate Term Tax

Exempt, but I live in New Jersey, so New Jersey Long Term Tax Exempt is a possibility. The amount of money to be invested is about 107K transferred from a brokerage account. I am

retired, will begin RMD's this year and will be adding this money to the Three Fund Portfolio. I have a substantial regular IRA and adequate funds for two years expenses, so the Three

Fund Portfolio money will not be needed for several years(hopefully). Thank you Mr. Bogle and Bogleheads.

An answer to the question of which bond fund to substitute would be greatly appreciated.

Taylor Larimore · Post by **Taylor Larimore** » Thu Jan 05, 2012 3:17 pm

Hi Cid:

What would be recommended as a substitute for Total Bond in the Three Fund Portfolio if money has to be invested in a taxable account? I would lean towards Intermediate Term Tax Exempt, but I live in New Jersey, so New Jersey Long Term Tax Exempt is a possibility.

I was surprised to see that Morningstar gives both funds the same credit quality. Duration is similar.

If you are in a high income tax bracket the tax-exempt fund might be favored--otherwise I'd probably go with the more diversified non-state specific fund for more safety and sleeping well.

I think that either of the two funds you mention should provide safety and Income in a taxable account.

If you have stocks in tax-advantaged accounts, they are taking up valuable space better used for higher yielding taxable bonds.

Best wishes
Taylor

Boglenaut · Post by **Boglenaut** » Thu Jan 05, 2012 3:20 pm

Alf 101 wrote: So I thought I could use these 3 funds to create my own "Total International" but in doing so gives me a holding with 4838 fewer stocks. Thus it does not seem that what I have in my Roth right now is as diversified. However, as regards costs, admiral TISM has an ER of 0.20%. The admiral classes of European and Pacific have a 0.14% ER, whereas admiral Emerging Markets is 0.22%. So I would need to pay a little more for greater diversification.

Don't forget you get Canada and International Small Cap in VG's TISM. So if you added EWC and VSS to your Europe/Asia/EM funds, it is very close in costs.

VG TISM is the way to go. One fund sure is simpler than 5.

ruralavalon · Post by **ruralavalon** » Thu Jan 05, 2012 3:21 pm

Muchtolearn wrote: I like that golfallday. A 2-fund portfolio. Makes life simple although there is less "diversification" although as you say, US stocks now have half their earnings abroad and probably international stocks have half their earnings here. So it may be all a wash. At least I'm going that way.

Its not all a wash,the difference is that with just TSM you seriously underweight certain sectors of the world economy, such as: electrical equipment; household durables; automobiles and auto components; and office electronics.
https://institutional.vanguard.com/VGAp ... nvestTrap2

CABob · Post by **CABob** » Thu Jan 05, 2012 3:45 pm

cid64 wrote:What would be recommended as a substitute for Total Bond in the Three Fund Portfolio if money has to be invested in a taxable account? I would lean towards Intermediate Term Tax Exempt, but I live in New Jersey, so New Jersey Long Term Tax Exempt is a possibility. The amount of money to be invested is about 107K transferred from a brokerage account. I am retired, will begin RMD's this year and will be adding this money to the Three Fund Portfolio. I have a substantial regular IRA and adequate funds for two years expenses, so the Three Fund Portfolio money will not be needed for several years(hopefully). Thank you Mr. Bogle and Bogleheads.

An answer to the question of which bond fund to substitute would be greatly appreciated.

Can you increase your bonds in your tax advantaged accounts so you can invest in equities in the taxable account? If you can this would make the problem disappear and maintain more tax efficiency.

natureexplorer · Post by **natureexplorer** » Thu Jan 05, 2012 3:46 pm

Cash wrote:
Taylor Larimore wrote:
Cash wrote:Taylor, might you one day simplify even further to Vanguard Total World + Total Bond Market?
It is certainly an intriguing alternative if Vanguard Total World had similar cost and was equally as diversified as the two stock funds in the 3-fund portfolio.

Number of stocks:
Total Stock Market: 3344
Total International: 6700
...
To Vanguard's credit, they recently announced an index change for Total World:

In order to include U.S. and international small-capitalization stocks that weren't in its previous target benchmark, the fund now seeks to track the FTSE® Global All Cap Index. This benchmark is designed to measure the performance of large-, mid-, and small-capitalization stocks worldwide, with appropriate capitalization weighting. The index is also float-adjusted, so its weighting only includes shares that are available for purchase, as opposed to all outstanding shares.

Vanguard Total World Stock Index Fund invests in a broadly diversified sampling from its benchmark, which is made up of nearly 7,400 securities in 47 different countries and captures 98% of the world's investable stock market capitalization. About 56% of the index is made up of non-U.S. stocks.
https://personal.vanguard.com/us/insights/article/fund-announcement-12192011 (emphasis added)

This gives me hope that Vanguard will continue to lower costs and increase diversification.

It sounds like Total Stock and Total International roughly hold a combined 11,000 stocks. Why does Total World hold only 7,400?

555 · Post by **555** » Thu Jan 05, 2012 3:47 pm

ruralavalon wrote:
Muchtolearn wrote: I like that golfallday. A 2-fund portfolio. Makes life simple although there is less "diversification" although as you say, US stocks now have half their earnings abroad and probably international stocks have half their earnings here. So it may be all a wash. At least I'm going that way.

Its not all a wash,the difference is that with just TSM you seriously underweight certain sectors of the world economy, such as: electrical equipment; household durables; automobiles and auto components; and office electronics.
https://institutional.vanguard.com/VGAp ... nvestTrap2

That's a very good point.

gabylon · Post by **gabylon** » Thu Jan 05, 2012 4:55 pm

Valuethinker wrote:I think the investor should also hold a decent slug of TIPS. I would say towards half of all bond portfolios (or 20-30% of total portfolio). In addition, one should consider I Bonds and CDs when these are attractive. Ditto municipal bonds. (ie when tax considerations and after tax yields make them attractive).

*however* at current TIPS yields that's a distraction. History says they will be available at higher real yields, in the future. At negative real yields, the investor is paying a fairly high price for inflation protection right now (at least relative to historic)

The way I see it, this doesn't mean that, by avoiding TIPS and holding only nominal bonds, the investor is guaranteed to avoid "paying this fairly high price for inflation protection right now." The nominal bonds can also turn out to have an even lower negative real yield.

cid64 · Post by **cid64** » Thu Jan 05, 2012 5:36 pm

Taylor Larimore wrote:Hi Cid:

What would be recommended as a substitute for Total Bond in the Three Fund Portfolio if money has to be invested in a taxable account? I would lean towards Intermediate Term Tax Exempt, but I live in New Jersey, so New Jersey Long Term Tax Exempt is a possibility.

I was surprised to see that Morningstar gives both funds the same credit quality. Duration is similar.

If you are in a high income tax bracket the tax-exempt fund might be favored--otherwise I'd probably go with the more diversified non-state specific fund for more safety and sleeping well.

I think that either of the two funds you mention should provide safety and Income in a taxable account.

If you have stocks in tax-advantaged accounts, they are taking up valuable space better used for higher yielding taxable bonds.

Best wishes
Taylor

I do have a regular IRA which is 30% Total Bond, 30% TIPS, 10% Short Term Corporate, 20% Total Stock, 7% Total International and 3% REIT. My age is 70. Just following Mr. Bogle's

suggestions. The 107K is to be kept in a separate account for a specific purpose, but with a little more growth and risk in mind. My wife and I can live off of our RMD

distributions each year. I will follow your advice and go with the non-state specific fund for the bond portion of our "special" fund.

Thank you for your advice today and over the years.

Regards
Bob

legion · Post by **legion** » Thu Jan 05, 2012 6:02 pm

Taylor Larimore wrote:Bogleheads:

After a lifetime of investing since 1950 trying to "beat the market," I am convinced that a simple 3-fund (or ETF) portfolio of Total Stock Market, Total International, and Total Bond Market, properly balanced, is an ideal portfolio for most investors. The advantages are many:

* Maximum diversification with over 10,000 worldwide securities (lower risk).
* No worry about under-performing the index.
* Very low-cost (including hidden transaction costs).
* Very high tax-efficiency (converts tax-inefficient stocks to tax-efficient stocks).
* No manager risk.
* No style drift.
* No sub-index "front-running."
* Simple to understand and maintain.
* More time with family and friends.
* High probability of outperforming most funds. Morningstar's 15-year Category Performance (12-31-2011):

TOP 29% = Vanguard Total Stock Market
TOP 16% = After tax.

TOP 35% = Vanguard Total International
TOP 19% = After tax

TOP 25% = Vanguard Total Bond Market
TOP 20% = After tax

Addendum:

* Place Total Bond Market in a tax-deferred account.
* In taxable accounts, high-income investors may substitute a tax-exempt bond fund for Total Bond Market.
* Larger portfolios may benefit from adding TIPS, REIT, or a Small-Cap Value fund in tax-deferred accounts.

What experts say:

American Association of Individual Investors: "It should come as no surprise that behavioral finance research makes a strong case for buying and holding low-cost, broadly diversified index funds."

Christine Benz, Morningstar Director of Personal Finance: "A single, broadly based index fund can give you exposure to the whole stock or bond market, enabling you to build an entire portfolio with just one or two funds."

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."

Warren Buffett: "I will take the market return and be happy with it, because I know the odds of beating the market over my investing lifetime are slim."

Scott Burns, columnist, author: "The odd are really, really poor than any of us will do better than a low-cost broad index fund."

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, author: "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: "Whether you decide to tilt toward value depends on whether you are willing to bear the associated risk...The market portfolio is always efficient...For most people, the market portfolio is the most sensible decision."

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."

E.F.Moody, author, advisor" "I am increasingly convinced that the best investment advice for both individual and institutional equity investors is to buy a low-cost broad-based index fund that holds all the stocks comprising the market portfolio."

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

Jane Bryant Quinn, author and syndicated columnist: "The dependable great investment returns comve from index funds which invest in the stock market as a whole."

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."

Gus Sauter, "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 of Money magazine: "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."

Happy New Year!

Taylor

Agreed, that's my portfolio

Triple digit golfer · Post by **Triple digit golfer** » Thu Jan 05, 2012 6:58 pm

I invest using as close to the Three Fund Portfolio as possible. The only difference is that instead of a Total Stock Market index fund, I use an S&P 500 and S&P 400 mixture at an 85/15 ratio.

Close enough for me.

FrugalInvestor · Post by **FrugalInvestor** » Thu Jan 05, 2012 7:02 pm

Triple digit golfer wrote:I invest using as close to the Three Fund Portfolio as possible. The only difference is that instead of a Total Stock Market index fund, I use an S&P 500 and S&P 400 mixture at an 85/15 ratio.

Close enough for me.

Why do you choose to do that instead of TSM?

Post by **LadyGeek** » Thu Jan 05, 2012 8:12 pm

This thread is now in the wiki.

Wiki article link: Lazy Portfolios

Wiki article link: Three-fund portfolio

umfundi · Post by **umfundi** » Thu Jan 05, 2012 9:10 pm

LadyGeek wrote:This thread is now in the wiki.

Wiki article link: Lazy Portfolios

Wiki article link: Three-fund portfolio

It's not only a Wiki, I see it's a sticky!!

Keith

Triple digit golfer · Post by **Triple digit golfer** » Thu Jan 05, 2012 9:26 pm

FrugalInvestor wrote:
Triple digit golfer wrote:I invest using as close to the Three Fund Portfolio as possible. The only difference is that instead of a Total Stock Market index fund, I use an S&P 500 and S&P 400 mixture at an 85/15 ratio.

Close enough for me.

Why do you choose to do that instead of TSM?

The only decent investment options in my 401(k) are the S&P 500 and the S&P 400 index funds. There is no Total International and no Total Bond, so I hold those in my IRA. I use the S&P 500 and S&P 400 index funds in my 401(k) because there is nothing else for me to hold in there (the rest of the funds are actively managed funds with 1.50%+ expense ratios).

stemikger · Post by **stemikger** » Thu Jan 05, 2012 10:59 pm

Thank you Taylor. For someone who is not a fan of International, can they do this with just two funds or possibly one? I remember reading in Common Sense on Mutual Funds, Mr. Bogle saying a simple balanced index fund can do the trick for most investors.

Cheers and Happy New Year to you and Pat.

Steve G.

FrugalInvestor · Post by **FrugalInvestor** » Fri Jan 06, 2012 12:29 am

stemikger wrote:Thank you Taylor. For someone who is not a fan of International, can they do this with just two funds or possibly one? I remember reading in Common Sense on Mutual Funds, Mr. Bogle saying a simple balanced index fund can do the trick for most investors.

Cheers and Happy New Year to you and Pat.

Steve G.

One potential downside to the single fund approach is less tax efficiency. If you have both taxable and non-taxable accounts it's best to position the stock index fund(s) in taxable and bond index fund (except munis) in non-taxable. You lose this flexibility with the one-fund option. In certain circumstances re-balancing can also be more tax efficient when you have both types of accounts. Of course if your total portfolio is in one or the other (taxable or non-taxable) then this is not an issue.

Taylor Larimore · Post by **Taylor Larimore** » Fri Jan 06, 2012 7:43 am

stemikger wrote:Thank you Taylor. For someone who is not a fan of International, can they do this with just two funds or possibly one? I remember reading in Common Sense on Mutual Funds, Mr. Bogle saying a simple balanced index fund can do the trick for most investors.

Cheers and Happy New Year to you and Pat.

Steve G.

Hi Steve:

If you do not want international in your asset allocation, it is very acceptable two use only two funds: Total Stock Market and Total Bond Market. This is what Mr. Bogle wrote in The Little Book of Common Sense Investing:

"

Deep down, I remain absolutely confident that the vast majority of American families will be well served by owning their equity holding in an all-U.S. stock-market index portfolio and holding their bonds in an all-U.S. bond-market index portfolio."

Best wishes.
Taylor