Skip to Content
Rekenthaler Report

The 3-Fund Portfolio

Living the simple investment life.

3 Is Company
Three colors: red, white, and blue. Three funds:  Vanguard Total Stock Market Index (VTSAX),  Vanguard Total International Stock Index (VTIAX), and  Vanguard Total Bond Market Index (VBTLX). According to author Taylor Larimore, those are all that an American investor needs.

All right, he doesn't actually mention the U.S. flag. That was my addition, this being a July 4 column. However, Taylor's new book, "The Bogleheads' Guide to the Three-Fund Portfolio," is less topical. It is intended to apply not only to each day of the year, but for many years to come. In that task, it succeeds. The publication is as timeless as anything that advocates specific funds can be. 

For one, Taylor's suggested funds are passive, meaning that they will not change their ways, even as their portfolio managers come and go. Also, those three indexes are very broad, capturing 1) the entire U.S. stock market, 2) all major non-U.S. equities, and 3) most investment-grade domestic bonds, respectively. That breadth makes their investment characteristics highly stable. Finally, the sponsor is Vanguard. It isn't going anywhere.

You likely can guess the reasons that Taylor gives for his recommendations:

1) Extremely low costs
2) Simplicity
3) Diversification
4) Ease of monitoring

To that final item, Taylor writes, "I probably spend about an hour a year managing my stay-the-course portfolio. I leave it to you to imagine what you can do with all the time you will be saving investing in this way." (Subversive words, Mr. Larimore. Where would Morningstar (MORN) be if all investors thought like you?)

Allocating Assets
The proportions of the three funds are up to the buyer. When it comes to asset-allocation suggestions, some investment writers invoke science and some do not. Taylor does not.

For the stock vs. bond decision, he invokes a well-known rule of thumb: Consider placing your age in bonds, with the rest in stocks. That, naturally, is a starting point. The aggressive investor will dial up the equity percentage, while the conservative investor will notch it down. But prospective investors won't go too far wrong if they adopt the neutral position.

In advising how to divide among the stock funds, Taylor uses not one, but two rules of thumb. Vanguard advises investing at least 20% of one's equity assets outside the United States. In contrast, Taylor's guiding spirit, Vanguard founder Jack Bogle, regards 20% as a maximum position. Two esteemed parties, intersecting at but a single point. And that is Taylor's answer: 20%.

In Response
I have no quarrels with Taylor's seemingly offhand approach to asset allocation. I have ample respect for the field's scientists (several of which are employed by Morningstar). The rigor that they bring is useful for understanding the implications of simple allocations, such as Taylor's, and essential for complex portfolios. One should not allocate among 12 asset classes solely with heuristics. Sweating through the details is required.

However, Taylor's portfolio has not 12 asset classes, but rather three. In addition, the questions raised by his three asset classes can't be solved by number crunching. How to allocate between stocks and bonds depends not only on individual risk tolerance but on market behavior. One 20-year period will yield a very different result than another. Similarly, despite quantitative analysts' best efforts, the "correct" amount for a U.S. investor to put overseas remains undiscovered. That decision is largely a matter of taste.

Where the three-fund portfolio's allocation can be criticized is for what it neglects. It covers its three asset classes (or four, depending upon how you regard small-company U.S stocks) extremely well. But the portfolio features no junk bonds; no directly held real estate; no commodities; and no alternative strategies. It is very much not the endowment model--that is, what most large foundations would consider to be best investment practices.

Individuals vs. Institutions
That is not as much of a problem as would first seem.

To be sure, institutional investors are the industry's elite, being among the best-trained and best-staffed of professional managers. What's more, unlike most mutual funds (target-date funds being a notable exception), endowment funds are complete portfolios, rather than slices to fill an allocation. In that respect, they resemble a retail investor's holdings. Which suggests that where Yale's endowment fund goes, Yale's alums (along with all other individual investors) should follow.

That is true, to a point. The problem is that many institutional favorites are unavailable to the rank and file. For example, at last report, Yale had 16% of its assets in venture-capital funds and 15% in leveraged-buyout funds. Over time, that 31% stake figures to outgain the stock market, albeit while assuming somewhat higher risk and conceding liquidity. Such a percentage would be too high for most retail investors, but they likely would benefit from a smaller dose. No such luck. Those funds aren't sold to the masses.

Thus, for his book's audience--meaning me, and presumably you--Taylor's asset allocation is sufficient. Let's put it this way: It is a terrific starting point for novice investors and a perfectly sensible ending point for the experienced. Of course, there will always be those who seek more. For such investors, the three-fund portfolio would be a suitable core position, from which they could explore additional purchases.

A Modest Proposal
Which brings me to a suggestion. The three-fund portfolio, to be sure, is simple to implement. But it would be simpler yet if it were a one-fund portfolio. It strikes me that Vanguard might do its investors a favor by bundling Taylor's three funds into a single offering: Vanguard Total Index Fund. Not total U.S. stock, nor total bond, not international stock, but rather "total index." All three of those asset classes combined, according to their global market-cap weighting. Then Taylor could write a new book, "The Bogleheads' Guide to the One-Fund Portfolio."

That task shouldn't take him long.

Postscript: Low-cost investing, it appears, brightens more than just financial health. Jack Bogle, famously, is 89 years old and going strong. (He currently is working on his 12th book.) Mr. Larimore is five years older yet, being born in 1924. The same year as the first mutual fund!


John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler has a position in the following securities mentioned above: MORN. Find out about Morningstar’s editorial policies.