The Three-Fund Portfolio

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tres arcenes
Posts: 4
Joined: Mon Mar 01, 2021 7:38 pm

Re: The Three-Fund Portfolio

Post by tres arcenes »

I've decided to simplify things using the three-fund portfolio. I'll use I-shares ETF's. ITOT for Total U.S. Market and IXUS for Total International Stock.
I'm struggling on the Bond fund. My thinking and research leads me to believe that the Bond fund should be oriented to short term bonds in nature with high credit quality bonds. IGSB is "1 to 5 year Investment Grade Corp" with an average bond duration of 2.77 years. IEI is "3-7 year Treasury Bond Fund" with obviously the best credit ratings (AAA) with an average bond duration of 4.60 years. I am avoiding a typical "Total Bond Fund" to eliminate exposure to long-term bonds since (in theory) the risk of owning long-term bonds outweighs the minimal benefits of better returns. Any thoughts on my funds/logic would be greatly appreciated.
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ruralavalon
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Location: Illinois

Re: The Three-Fund Portfolio

Post by ruralavalon »

tres arcenes wrote: Sun Apr 04, 2021 1:23 pm I've decided to simplify things using the three-fund portfolio. I'll use I-shares ETF's. ITOT for Total U.S. Market and IXUS for Total International Stock.
I'm struggling on the Bond fund. My thinking and research leads me to believe that the Bond fund should be oriented to short term bonds in nature with high credit quality bonds. IGSB is "1 to 5 year Investment Grade Corp" with an average bond duration of 2.77 years. IEI is "3-7 year Treasury Bond Fund" with obviously the best credit ratings (AAA) with an average bond duration of 4.60 years. I am avoiding a typical "Total Bond Fund" to eliminate exposure to long-term bonds since (in theory) the risk of owning long-term bonds outweighs the minimal benefits of better returns. Any thoughts on my funds/logic would be greatly appreciated.
I think you may be overestimating the possible impact of long bonds in a total bond market index fund.

For a bond fund look at iShares Core US Aggregate Bond ETF (AGG) ER 0.04%. That ETF is a total bond market index fund and tracks the Bloomberg Barclays U.S. Aggregate Bond Index. The effective duration = 5.92 years, and the credit quality = AA, only about 8% in bonds with a duration of 6 years or more.

iShares 1-5 Year invmt Grd Corp Bd ETF (IGSB) ER 0.06%
is a good bond fund too. The effective duration is lower at 2.77 years, and the credit quality = A is lower too. Corporate bonds are somewhat riskier.

My preference is either total bond market or intermediate-term. We use Vanguard Intermediate-term Bond Index fund (VBILX) ER 0.07%, about 1/2 government bonds, 1/2 corporate bonds, with no mortgage backed securities (MBS), effective duration = 6.60 years, credit quality = A.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
tres arcenes
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Joined: Mon Mar 01, 2021 7:38 pm

Re: The Three-Fund Portfolio

Post by tres arcenes »

Thanks for your response. It helps in my evaluation. Because this will be allocated in different funds, some of the bonds will have to use a Fidelity account (401k). Unfortunately, the ER on all of the available bond funds in the 401(k) plan is like .65%. Fortunately though, the 401(k) will only get 12.5% of the total bond funds.
manlymatt83
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Joined: Tue Jan 30, 2018 8:23 am

Re: The Three-Fund Portfolio

Post by manlymatt83 »

Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
harshabogle
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Joined: Thu Mar 11, 2021 7:26 pm

Re: The Three-Fund Portfolio

Post by harshabogle »

tres arcenes wrote: Mon Apr 05, 2021 7:51 pm Because this will be allocated in different funds, some of the bonds will have to use a Fidelity account (401k). Unfortunately, the ER on all of the available bond funds in the 401(k) plan is like .65%.
Do you have access to BrokerageLink in your 401k at Fidelity? If yes, and if there is no plan cost for using BrokerageLink (this depends on the terms of your 401k plan), then you might be able to access a much broader universe of mutual funds with a lower ER, including bond funds.
Triple digit golfer
Posts: 7251
Joined: Mon May 18, 2009 5:57 pm

Re: The Three-Fund Portfolio

Post by Triple digit golfer »

manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
sman09
Posts: 313
Joined: Fri Mar 23, 2018 12:02 am

Re: The Three-Fund Portfolio

Post by sman09 »

Triple digit golfer wrote: Tue Apr 06, 2021 12:52 pm
manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
Triple digit golfer:

Could you please elaborate why you say
"I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks."
My understanding was stock index funds in general are okay in taxable/tax-deferred accounts while bonds are better in tax-deferred ones. Being so, wanted to know the reason for your suggestion.

Thank you.
tj
Posts: 4258
Joined: Thu Dec 24, 2009 12:10 am

Re: The Three-Fund Portfolio

Post by tj »

sman09 wrote: Wed Apr 07, 2021 10:53 pm
Triple digit golfer wrote: Tue Apr 06, 2021 12:52 pm
manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
Triple digit golfer:

Could you please elaborate why you say
"I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks."
My understanding was stock index funds in general are okay in taxable/tax-deferred accounts while bonds are better in tax-deferred ones. Being so, wanted to know the reason for your suggestion.

Thank you.
You don't get the foreign tax credit if you use the global ETF.
bogledogle87
Posts: 356
Joined: Wed Sep 26, 2018 7:03 pm

Re: The Three-Fund Portfolio

Post by bogledogle87 »

sman09 wrote: Wed Apr 07, 2021 10:53 pm
Triple digit golfer wrote: Tue Apr 06, 2021 12:52 pm
manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
Triple digit golfer:

Could you please elaborate why you say
"I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks."
My understanding was stock index funds in general are okay in taxable/tax-deferred accounts while bonds are better in tax-deferred ones. Being so, wanted to know the reason for your suggestion.

Thank you.
Add about 0.10% to the expense ratio to account for the loss of the Foreign Tax Credit eligibility. Note that this underlying expense is also present in retirement account types as well. In taxable, you do have an opportunity to get that expense back by splitting up, as suggested. There is a good argument on both sides on whether 1 or 2 funds is worth that credit or not.
VTWAX and chill
Triple digit golfer
Posts: 7251
Joined: Mon May 18, 2009 5:57 pm

Re: The Three-Fund Portfolio

Post by Triple digit golfer »

sman09 wrote: Wed Apr 07, 2021 10:53 pm
Triple digit golfer wrote: Tue Apr 06, 2021 12:52 pm
manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
Triple digit golfer:

Could you please elaborate why you say
"I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks."
My understanding was stock index funds in general are okay in taxable/tax-deferred accounts while bonds are better in tax-deferred ones. Being so, wanted to know the reason for your suggestion.

Thank you.
Vanguard Total World Stock (VT or VTWAX), as I understand it, is not eligible for the foreign tax credit. Therefore, it's not that it isn't okay to use in a taxable account, but you can get the same portfolio using two funds/ETFs (VTI/VTSAX and VXUS/VTIAX) and still get the foreign tax credit on VXUS/VTIAX.

Does that make sense?

If you're okay giving up the credit, then by all means, VT/VTWAX isn't a bad fund. It's just that you could do a little bit better without any cost or risk. If you value simplicity over anything else, which I can certainly understand, use VT/VTWAX and don't think twice about it. It's not like the fund is inefficient, it just isn't as efficient as the combination of the other two, the difference being the foreign tax credit.
muffins14
Posts: 531
Joined: Wed Oct 26, 2016 4:14 am

Re: The Three-Fund Portfolio

Post by muffins14 »

manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
You could also just buy VTI & VXUS one time at exactly the market proportion, and then *not* rebalance back to some arbitrary non-market number like 60% US / 40% international. It would have the same effect as buying VT in that it will track the market without rebalancing
sman09
Posts: 313
Joined: Fri Mar 23, 2018 12:02 am

Re: The Three-Fund Portfolio

Post by sman09 »

Triple digit golfer wrote: Thu Apr 08, 2021 8:20 am
sman09 wrote: Wed Apr 07, 2021 10:53 pm
Triple digit golfer wrote: Tue Apr 06, 2021 12:52 pm
manlymatt83 wrote: Tue Apr 06, 2021 11:36 am Just came across a little bit of unexpected cashflow ($XX,XXX). I want to buy VTWAX in taxable with it (as part of my overall allocation). Reasons:

- I know I won't touch it. If I buy VT, I might do something like sell covered calls, etc. due to current valuations.
- I love the idea of not having to rebalance between VTI & VXUS, or the thought of overweighting one vs. the other.

I realize I'd lose the foreign tax credit. But for sub $100k, is it really that big of a deal in the grand scheme of things?
Do you have new contributions going into this account as well? You can rebalance that way.

I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks.

If you don't mind giving up what may be a couple hundred bucks a year (just a guess), so be it. I would not.
Triple digit golfer:

Could you please elaborate why you say
"I would not use VT or VTWAX in a taxable account. We can control few things in investing, and tax efficiency by using two funds instead of one is an easy thing do to earn a few extra bucks."
My understanding was stock index funds in general are okay in taxable/tax-deferred accounts while bonds are better in tax-deferred ones. Being so, wanted to know the reason for your suggestion.

Thank you.
Vanguard Total World Stock (VT or VTWAX), as I understand it, is not eligible for the foreign tax credit. Therefore, it's not that it isn't okay to use in a taxable account, but you can get the same portfolio using two funds/ETFs (VTI/VTSAX and VXUS/VTIAX) and still get the foreign tax credit on VXUS/VTIAX.

Does that make sense?

If you're okay giving up the credit, then by all means, VT/VTWAX isn't a bad fund. It's just that you could do a little bit better without any cost or risk. If you value simplicity over anything else, which I can certainly understand, use VT/VTWAX and don't think twice about it. It's not like the fund is inefficient, it just isn't as efficient as the combination of the other two, the difference being the foreign tax credit.
Thank you
- tj
- bogledogle87
- Triple digit golfer

That helps me to understand the reason.

Another question I have had in my mind for a while is about having bonds (such as Total Bond Market fund) in taxable - will perhaps post as a separate thread.

Thank you!
tres arcenes
Posts: 4
Joined: Mon Mar 01, 2021 7:38 pm

Re: The Three-Fund Portfolio

Post by tres arcenes »

harshabogle wrote: Tue Apr 06, 2021 12:33 pm
tres arcenes wrote: Mon Apr 05, 2021 7:51 pm Because this will be allocated in different funds, some of the bonds will have to use a Fidelity account (401k). Unfortunately, the ER on all of the available bond funds in the 401(k) plan is like .65%.
Do you have access to BrokerageLink in your 401k at Fidelity? If yes, and if there is no plan cost for using BrokerageLink (this depends on the terms of your 401k plan), then you might be able to access a much broader universe of mutual funds with a lower ER, including bond funds.
Thank you for your response. I checked and I do not have access to BrokerageLink. However, I did find out that the 401(k) plan allows for in-service withdrawals at 59 1/2. I'm coming up on that will make a direct rollover to an existing IRA so I'll be able to reduce the ER substantially that way.
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