When I recommended an investment plan for Stacey, I suggested she setup a three fund portfolio. It’s a simple, straightforward target that will accomplish the investment goals of a vast majority of people. In fact, it’s my default recommendation to anyone who asks for allocation advice. And this question has been nagging at me ever since: Should I switch to a three fund portfolio myself?
My Current Allocation
A few years ago, my wife and I agreed to an Investment Plan. Part of that plan includes a target for our retirement portfolio investments:
65% Stock | 30% Bond | 5% REIT
For us, REIT simply means a 5% stake in Vanguard Real Estate Index Fund Admiral Shares (VGSLX). Simply done.
Your bond allocation should make you uncomfortable, and I sure don’t like mine. I wake up thinking it should be smaller and I go to sleep thinking it should be bigger — so it’s just about right for us. Originally, we had this split up between domestic and international bond funds. But I couldn’t justify the international bond fees so this category became simple, too: 30% stake in Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX).
Incidentally, If you have a few different retirement accounts between IRAs, 401(k)s, 403(b)s, 457(b)s, and regular taxable accounts; the ubiquity of VBTLX can really help you when it’s time to rebalance.
Our IPS calls for the stock stock portion of our portfolio to be split 60% Domestic and 40% International. At the time we created this plan, I had read a lot about how slicing and dicing within asset classes wasn’t that important, but might bring modest returns over an undifferentiated allocation. I love tracking, and I don’t mind a little bit of complication, so we settled on this target:
It’s really fun to set up a portfolio like this. I like optimizing holdings between different accounts, and I think there truly is some value (maybe around 0.5% per year) to sticking diligently to an asset allocation like this one. Principally, this is because I’m forced to “buy low” when a certain asset class (like international stocks in 2018) falls out of favor and “sell high” when an asset class performs well. Note, I’m not actively buying and selling, just keeping to my target allocation by adjusting contributions or rebalancing not more than once per year! Inevitably, the high flyers come back to earth and the stragglers catch up. Sticking to an allocation is a contrarian game that I think produces results.
Did I mention, I really enjoy tracking the components? I do. See more about that below.
Oh, are you trying to have fun with your portfolio? Be careful, there’s a lot of “fun” ways to lose your shirt. As a rule, good investing should be simple and boring.
Keeping it simple also means you can spend more time doing other stuff; you have fewer things to keep track of and fewer moving parts to distract you. I’m a bit jealous when I see someone who is just 100% VTSAX. They don’t spend any time hemming or hawing about where to put their money: it’s fire and forget.
The last downside, which I’ve been thinking about lately, is for my wife and kids. The reason to buy life insurance is to make sure that my unexpected death would not imperil the livelihood of those who depend on me. My wife is hard working and smart, but I don’t think she’s that interested in managing a more complicated portfolio. There’s real value in simplicity if I get older and start to lose my mental faculty, or if I’m unexpectedly dispatched.
Alternate Allocation – Three Fund Portfolio
The three fund portfolio would replace my current stock allocation target with a 60% VTSAX and 40% VTIAX. The bond portion would stay just the same, and I’ll ignore the little bit of REIT for now.
I just have this idea from books I’ve read that my portfolio is likely better than this simple three fund design. But is it? We don’t know what the future will bring, but I have really specific data from the past. Below I’ll compare my actual 2017 returns with what I would have received under this alternate allocation
Comparison Analysis: Three Fund Portfolio
I keep track of the internal rate of return for my whole portfolio as well as each individual component of the overall strategy.
My Target Portfolio gave me better performance than the alternate Three Fund Portfolio would have in 2017.
Here’s my personal returns for 2017, based on the target allocation described above.
|End of Year Allocation||Asset||Return|
|18.85%||US Large Blend||17.40%|
|5.57%||US Large Value||24.41%|
|8.81%||US Mid Value||22.15%|
|5.46%||US Small Value||19.08%|
|12.76%||Foreign Large Blend||29.26%|
Let’s replay the year, making all the same contributions on the same dates. But instead of breaking US Stocks and International Stocks into sub categories, just by the “parent” index in the three fund portfolio – either VTSAX or VTIAX.
Here’s the same table of results compared with the Three Fund Portfolio:
|Asset Class||My Actual Return||Three Fund Return|
|Bonds||2.35%||2.35% (the same)|
Conclusion: Should I Switch to a Three Fund Portfolio?
My hypothesis is rejected: The three fund portfolio outperformed my own target portfolio for 2017 (19.23% vs 18.89%).
Reasons to Stay With My Current Allocation
Despite the evidence that a simpler portfolio really would have been better in 2017, it is just one year. I never expected a huge effect, and I certainly wouldn’t expect to “win” every year. Furthermore, the whole point of an Investment Plan is not to change course on trends and whims. I think it doesn’t matter as much what your chosen allocation is, it matters if you stick to it through thick and thin. We have a six month “cooling off” period for any changes in our plan – and the changes have to be in writing first!
We might have more tax loss harvesting opportunities with a variety of funds, rather than just the big three. Also, I’m employed in a “growth” industry, so I could argue that investing in value stocks helps me to properly diversify my resources.
Reasons to Switch
Investing is simple. Complicating my plan just to make it more interesting is silly. I could save a lot of time tracking data and managing different holdings across different accounts. And it appears I could do that without really losing any returns – the three fund portfolio funds do have lower fees, which ultimately may drive their superior performance.
Finally, I had the idea to explore this topic when I was thinking about my estate plan. I like managing all the moving parts, but I think those who survive me would prefer a simpler picture.
So I think I’ll switch to a three fund portfolio.
I would sincerely appreciate any arguments for or against; especially any factors I haven’t considered yet.