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By Christine Benz | 10-17-2013 10:00 AM

Ferri: 3-Fund Portfolio the Simplest Way to Best Return

U.S.-stock, foreign-stock, and bond index funds can constitute a core portfolio with the flexibility to expand into other asset classes if desired, says author and advisor Rick Ferri.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I recently attended the annual Bogleheads Conference, where I sat down with investment advisor and author, Rick Ferri. We discussed how investors can assemble truly streamlined portfolios.

Rick, thank you so much for being here.

Rick Ferri: Thanks for having me, again. I appreciate it.

Benz: We’re here at the Bogleheads event. A lot of the investors here are big believers in minimalist portfolios, and in fact, they like this idea of a three-fund portfolio, where you just got a total U.S.-stock, total international-stock and total bond market index. Let’s talk about what is the advantage of having such a skinnied-down portfolio versus one that is including more moving parts?

Ferri: More complex.

Benz: Yes.

Ferri: Simplicity is always a good thing. I guess the older I get and the longer I'm in the business--I’ve been in the business now for 25 years--that the simplicity of a three-fund portfolio just makes more and more sense and becomes more obvious. And I’m not really convinced that having anything more than that is going to do anything more for you, except maybe make your life more complex.

The three-fund portfolio is composed on the stock side of a total stock market index fund, a total international-stock index fund, and then a total bond index fund, which in a taxable account could be a municipal-bond fund. So, it's an intermediate-term bond fund instead of a total bond market fund, but its three funds total.

[The portfolio] might be, in fact, the simplest and may actually offer--net of cost, net of back taxes, and everything else--the best return to the largest majority of people out there.

Benz: The obvious question is how does one apportion assets across these three funds if its someone who does believe in the idea of keeping it really simple? How do you decide how much to have in each of the three parts?

Ferri: The asset allocation within the three funds is personal. The philosophy of having index funds--because we believe that in the long-term index funds are going to outperform--it is the superior strategy. It is going to outperform most investors. It is not going to outperform the markets. But superior investing doesn’t mean outperforming the markets, it means outperforming your neighbors. So, indexing does that.

Then the question is the strategy. How are you going to develop your portfolio? How much are you going to have in equity? How much are you going to have in fixed income? On the equity side, how much in international and how much in U.S.? That is all based on your personal circumstances, and there’s no great rule of thumb I’ve ever seen that can say this is the way it should be. You can make a case either way for having more equity or less equity with people who have a lot of money or people who have a little bit of money. But on the international/U.S. side, I think, for me personally, I like to go with about one third international [exposure] and then two thirds U.S. [exposure].

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