Many people who want to start investing hold themselves back due to a lack of financial knowledge and uncertainty over navigating the complexities of investments. There’s no shortage of information out there giving advice on how to start and which stocks to choose, but combing through all of that information to choose the approach that works for you is often a major hurdle. That’s where the three-fund portfolio approach comes in. This is a simple yet effective investment strategy that provides a framework for investors of all knowledge levels, including beginners, to create a diversified asset portfolio that builds wealth while keeping costs low.
What Is a Three-Fund Investment Portfolio?
Taylor Larimore created the three-fund portfolio approach to investments. His inspiration came from the writings of John Bogle, who sought to simplify his own investments. This method advises investing in domestic stocks, international stocks, and bonds. Many investors choose index funds due to their diversity, moderate risk, consistent performance, and relatively low costs. How you allocate your investment funds between these three options depends on your personal financial goals, risk tolerance, and the investment timeline you have in mind.
Benefits of the Three-Fund Portfolio
Below are the biggest benefits of a three-fund portfolio to keep in mind.
Diversification
The three-fund portfolio achieves diversification of your portfolio while eliminating the guesswork associated with asset allocation. A diversified portfolio is essential to managing your risk level. Investing in a variety of funds spreads the risk, so if one of the included stocks performs poorly, the others can balance it out and prevent you from losing significantly on your investment.
Allocation of Funds
Many investors choose this approach because it is easy to follow and can be customized to fit their unique situation. Choosing how to allocate your funds into individual stocks takes considerable research and knowledge of how the stock market works. With the three-fund approach, you only need to determine how to divide your investment funds between US stocks, international stocks, and bonds. If you are starting a long-term investment plan and your anticipated retirement is still decades away, you may want to allocate the majority of your funds toward stocks in an 80/20 division. If you are closer to retirement, you may want to allocate more of your funds towards bonds, which are a safer investment option. From there, you need only to decide how much to put into US-based stocks and how much into international stocks.
Low Cost
The passive nature of index funds requires minimal management costs, which translates to lower costs for you to initiate your investment. You can expect to invest your money for the long term, instead of frequently trading and selling. If you are seeking a higher-risk investment with the potential for a significant payoff, then the three-fund portfolio may not be the right approach.
Moderate Risk
Index funds are moderate risk because your money isn’t tied to the performance of a single asset. However, the lower risk level they present also means that this type of fund typically doesn’t yield high rewards. Instead, they are steady, stable investments that aim to match the market rather than significantly outperform it. Although index funds are a more passive investment strategy, it’s still essential to monitor your portfolio and make changes when necessary to stay on track with your goals.
Ease of Investing
While three-fund portfolios limit your ability to invest in a broad range of options, like cryptocurrency, the nature of this approach makes it much easier, particularly for beginners. Since you are choosing just three funds for your portfolio, you only have to decide how to allocate between stocks and bonds.
How to Build Your Three-Fund Portfolio
Determine how much you can afford to invest by calculating your essential expenses, including savings, retirement, and paying down debt. It’s essential to budget wisely and remember that investments don’t guarantee a return. Therefore, evaluate your risk tolerance and avoid investing money you need for other purposes. Once you reach a comfortable estimate, try out an online calculator tool to estimate the potential return you may receive. This can help you clarify your long-term financial goals.
When you’re ready to invest, get started by setting up an online brokerage account, funding it, and selecting your index funds. Look for funds that have low investment costs but a high level of diversification. If you’re ready to start investing in your financial future but want some additional help to set and achieve your goals, then consider working with a financial advisor who can offer insights and advice tailored to your needs.
Whether you decide to begin investing on your own or with outside guidance, a three-fund portfolio is a smart option you should consider carefully. With moderate risk and lower initial costs, it’s an accessible option that is easy to start and rebalance as you learn to pay attention to the market and your changing financial goals.
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