How to Build a 3-Fund ETF Portfolio
Successful Investing Doesn’t Have to Be Complicated
The three-fund portfolio is a simple, low-cost investment strategy that has become popular with many investors. Whether you're just getting started or are a seasoned investor, the three-fund strategy works for everyone.
Exchange-traded funds (ETFs) can add extra diversity and stability to the three-fund portfolio. Find out how to make and maintain a three-fund ETF portfolio.
What Are 3 Fund ETF Portfolios?
The three-fund ETF portfolio strategy mimics the three-fund portfolio. It allocates stock and bond investments between three types of exchange-traded funds: a total U.S. stock market index fund, a total U.S. bond market index fund, and a world stock market fund (without U.S. investments).
ETFs are a cost-effective way to invest in many different stocks, bonds, and other assets. They're a basket of securities that are traded on exchanges like the NASDAQ and the New York Stock Exchange and have the following characteristics:
- They are liquid, just like individual stocks.
- They typically have very low expenses.
- They are transparent and publish their holdings daily.
Depending on the ETFs chosen for the portfolio, a three-fund ETF portfolio could provide investors with ownership of thousands of individual worldwide securities. How the specific funds are selected and allocated within the portfolio is up to the investor based on their preferences, time horizon and risk tolerance.
ETFs are available that track broad financial indexes, like the Wilshire 5000 and Barclays/Bloomberg Aggregate U.S. bond index. Index ETFs hold each of the securities that are included in the index being tracked.
How to Build a 3-Fund ETF Portfolio
Every investment plan begins with deciding on asset allocation and where the assets will be located. Decide how much of your portfolio you want to put in each ETF, according to your risk tolerance.
Asset allocation is how a portfolio is divided up across stocks, bonds, cash, and other types of investments to manage risk. How you allocate your funds should be compatible with your financial goals, time horizon, and risk tolerance. The table below is a sample of what a three-fund ETF portfolio and returns might look like.
|Sample 3-Fund ETF Allocations|
|Target||Total Stock ETF||Total World ETF (No U.S.)||Total U.S. Bond ETF||10-Year Return|
|Conservative (Low Risk)||30%||10%||60%||6.30|
|Moderate (Moderate Risk)||45%||15%||40%||7.70|
|Aggressive (High Risk)||50%||20%||30%||8.18|
You also need to decide where you want your assets located. Asset location refers to placing your investments in a type of account most beneficial for the specific kind of investment.
For instance, a tax-deferred account is good for bonds because they are taxed at the higher income tax rates rather than the capital gains tax rate. Stocks are taxed at the lower capital gains tax rate, so they would be better in a taxable account, depending on your tax bracket.
Your employer’s retirement plan is likely where most of your investment portfolio is early in your career. If you are further along, you may also have money in taxable accounts like a brokerage account or a tax-deferred account. In that case, you can decide where the investments go to yield the best results.
Rebalancing Your Portfolio
Rebalancing means moving money between the funds to maintain your desired allocation. Your allocation is likely to change over time as you build capital and move through your career.
For example, suppose you start with a $10,000 portfolio and invest 50% in a stock fund and 50% in a bond fund. After the second year, the portfolio grows to $12,000, and the allocation becomes 55% stock and 45% bond. To return to the original 50/50 allocation, you need only sell $600 of the stock fund and use it to purchase $600 worth of bonds.
The Benefits of a 3-Fund ETF Portfolio
Three-fund ETFs portfolios have some primary benefits that make them attractive to investors seeking returns and stability:
- They are less expensive than other portfolio builds
- They mitigate foreign investment risks
- Contributions and withdrawals are simple
- Fewer funds make it easier to rebalance
Investors gain significant diversification because each of the three ETFs holds thousands of different domestic and international securities. A highly diversified portfolio reduces risk without sacrificing too much return, especially when adding international and foreign investments.
Average expenses for ETFs are close to one-third of the average cost of a mutual fund. If you were to build a three-fund portfolio from mutual funds, you'd likely pay three times as much in fees as you would for an ETF-based portfolio.
Less asset movement within the portfolio combined with much lower fees means you keep more of your capital invested, increasing the value of your portfolio that much more.
The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.