What Is A 3 Fund Portfolio?
A 3 fund portfolio is a diversified investment plan comprising three different kinds of assets, i.e., domestic stocks, domestic bonds, and international stocks. In this kind of investment, the investors can choose the asset allocation mix and the funds based on their financial objective.
This plan aims to diversify retirement investments. As a result, investors can undertake this investment approach for their 401(k) to ensure the retirement savings benefit with tax advantage. Also, it gives a higher degree of control over the assets and, thus, helps manage and reallocate funds for risk adjustment.
Table of contents
- A 3 fund portfolio is a diversification approach whereby the investors put their money in a certain ratio in three different asset classes, i.e., domestic stocks, domestic bonds, and international stocks.
- It is a simple, low-cost investing approach that ensures retirement savings at a minimal risk appetite.
- The asset allocation mix should include the index funds representing the whole market to assure better performance.
- The investors design a 3 fund portfolio to suit their investment objective and exercise greater control over the underlying assets.
3 Fund Portfolio Explained
A 3 fund portfolio ensures diversification and, thus, minimizes risk in the long term. It includes two domestic asset classes, i.e., stocks and bonds, and an international stocks investment to offer growth opportunities independent of the domestic market condition. Indeed, domestic stocks boost the return potential while the bonds ensure stable returns to create a balanced portfolio. The fund is allotted to these three asset classes in a certain ratio. For instance, it can be 50% in domestic stocks, 30% in domestic bonds, and 20% in international stocks.
Moreover, such an investment plan provides freedom of asset allocation to match the investors’ long-term financial goals. Many investment advisors consider a 3 fund portfolio allocation a passive investment strategy. However, rebalancing the assets is still crucial to avoid losses. It is important to remember that the key to success in a 3 fund portfolio is to keep it simple from the start and invest in index funds that replicate the performance of a particular market.
Despite being cost-effective, such investment vehicles don’t provide impressive returns. Also, there are various alternatives, like real estate, which are more rewarding than 3 fund portfolio returns but with a higher risk level. A target date fund offers similar benefits with fewer complications.
How To Create?
Creating a 3 fund portfolio is all about strategies and decision-making. It normally involves the following steps:
- Determine Asset Allocation Ratio: The investors first need to decide the ratio in which the money will be invested in each asset class. It completely depends on the investors’ risk-taking capacity and long-term objectives. For example, suppose a young investor can take more risk and, thus, invest 64% in domestic stocks, 16% in international stocks, and 20% in domestic bonds.
- Select Funds: The investors must choose appropriate funds under each asset class while considering their investment goal. It is best to go for index funds that match the performance of the complete market. Including relevant exchange-traded funds (ETFs) is a good idea. Moreover, a financial advisor can greatly help with fund selection.
- Ensure Low Cost: An asset’s expense ratio immensely affects the fund’s returns and growth. Thus, investors should always include stocks and bonds with a low expense ratio and other charges to their portfolios.
- Rebalance: As we know, the risk-taking capacity of investors changes with their age and needs, and adjustment and revision of the portfolio become crucial in the long run until their retirement.
Check out this example to better understand the 3 fund portfolio allocation. Mr. A, a US citizen aged 44 years, plans to go for a 3-fund portfolio. He wants to invest $1500 every month for his retirement. Since he is a middle-aged investor, he is hesitant to take high risks and therefore selected the following asset allocation mix:
- 30% in domestic stocks, i.e., Vanguard Total Stock Market Index Admiral Shares (VTSAX);
- 40% in domestic bonds, i.e., Fidelity U.S. Bond Index Fund (FXNAX); and
- 30% in international stocks, i.e., Vanguard Total International Stock Index Fund Admiral Shares (VTIAX).
3 Fund Portfolio vs S&P 500
The 3 fund portfolios and S&P 500 are completely different investment vehicles that serve different investor objectives. Let us go through the differences between them below:
|3 Fund Portfolio
|A 3 fund portfolio is an asset allocation mix comprising three asset classes, domestic stocks, international stocks, and domestic bonds.
|Standard & Poor’s 500 is a market index that tracks the market value and performance of the top 500 US large-cap stocks.
|Domestic stocks, domestic bonds, and international stocks
|Market value-weighted index
|Control Over Components
|The investors have complete control over the percentage of money allocated to each asset category and the funds to be included in the portfolio.
|It is a standard market index where a committee of US industry representatives selects the components. The investors have no control over the components.
|Effect of Domestic Economy Changes
|It is comparatively less affected by domestic economic conditions since it includes international stocks.
|It is greatly affected by the US economic conditions since all the 500 underlying stocks belong to the US industries.
|It includes stocks listed in worldwide exchanges other than the New York Stock Exchange and NASDAQ.
|The index comprises only those stocks which are listed under NYSE and NASDAQ.
|Degree of Diversification
|It is more diversified than the latter since the investment is made in three different asset classes belonging to different markets (when the funds are invested in total index funds).
|It is comparatively less diversified as the money is invested in the same market, i.e., the US stock market.
|Retirement and Tax Benefits
|This strategy can be applied under a 401(k) account.
|No such benefit.
Frequently Asked Questions (FAQs)
Although a 3 fund portfolio is not suitable for every investor, it is a wise decision for investors seeking consistent retirement savings and wealth creation in the long run.
Moreover, it is a simple way of diversifying the portfolio. Also, it involves low risk (which can be regularly adjusted) and is comparatively more cost-effective than the other investment options when the investors opt for relevant index funds.
There is no best 3 fund portfolio since the one that seems best for an investor may not work for the other. However, a strategically designed high-performance 3 fund portfolio includes assets or index funds replicating the overall market.
Firstly, a 3 fund portfolio is not for everyone. The investors can use it in their 401(k) plan if they are beginners, want a simple but diversified asset allocation, and wish to have retirement savings and tax benefits. It is even suitable for investors who aim at tax savings.
This article has been a guide to what is a 3 Fund Portfolio. We compare it with S&P 500 and explain the topic in detail, such as how to create it, and an example. You may also find some useful articles here –