- There's a very easy do it yourself method to investing
that not only out performs the vast majority
of retail and professional investors,
but it also saves you a ton of time,
energy and money along the way,
and that investing method is called, wait for it,
the three fund portfolio.
In this video I'll show you what makes this way of investing
so successful, the steps to properly
create this portfolio in your account,
which aren't always so obvious.
I'll give you a list of the funds needed
to create the portfolio,
and then I'll show you the actual historical returns
based on a few back tested three fund portfolios
that I put together.
If you get some value from this video,
then please hit that thumbs up button.
If not for me, then please do it for my dog, Molly,
because she's starring at me right now
waiting for me to get done filming
so that we can go outside and play.
The three fund portfolio is made up of,
you guessed it, three different funds.
Nothing more and nothing less.
As with anything, you can of course customize it
beyond those three if you want,
but the results may vary based on how many shares
of speculative investments
that you decide to add beyond those three.
The three types of funds consist of
number one, a total U.S. stock market index fund,
which essentially holds every single stock
traded on the stock market.
We're talking small cap, mid cap,
and large cap stocks,
which makes up around 4,000 U.S. based companies.
Number two, a total international stock index fund
that excludes stocks that are headquartered
within the United States.
These are stocks that make up developed
and emerging international economies,
and are equal to roughly 7600 different stocks.
And finally, a total U.S. bond market index fund,
which consists of a mixture between maturities
that are short, intermediate and long term.
In total, there's a little over 10,000 of these.
When you own a total market index fund,
you basically have money invested
in essentially every single stock and bond
traded on the stock market.
Between these three funds,
you'd hold a little more than 21,500 different
stocks and bonds across the world
at the lowest cost possible.
You're instantly diversifying your money
by only having to worry about
purchasing three different funds.
As Jack Bogel, the guy who introduced the first
index fund to retail investors like us once said
"Why look for the needle,"
meaning those individual winning stocks,
"when you can just buy the whole haystack."
By investing in these three types of funds,
there is zero overlap
when it comes to stocks and bonds.
Portfolio overlap happens
when you invest in multiple funds
that hold the exact same stocks,
which in turn makes you less diversified
than you might think you are.
An easy way to remember this is
when diversification decreases,
your risk will increase.
Only having to own three different investments
sounds pretty simple, right?
- Yep.
- Like so simple that you don't even need to pay
one of those expensive professional advisors-
- What?
- To pick your investments
that will most likely
underperform the market in the long run, right?
- Yep.
- Did we just become best friends?
- Do you wanna go do karate in the garage?
- It's no secret that advisors make money off of you,
because that's how they get paid.
And the amount that they're paid comes directly
from the returns of your investments.
There's two main ways that they make money off of you.
Number one, by charging you either an ongoing percentage
based on your account balance,
which I've seen on average is about 1%,
or a flat fee no matter the size of your account.
And/or number two, by getting a cash kickback
from the company that manages the fund
they're having you invest in.
I don't know if you caught that,
but it sounds like there might be
a little bit of a conflict of interest for that one, right?
Of course there is,
but naturally they're gonna try to hide that from you.
If an investment advisor told you to invest
in the same three low cost funds for the rest of your life,
would you be willing to pay them an ongoing 1% fee
every single year?
Would it be worth paying them $20,000 in fees?
Because if you invested $10,000 today,
and paid them 1% per year for 30 years,
then the total fees that you would pay
from the annual fees plus the opportunity cost,
would add up to $19,800.
Now, let me put that in terms that we can all understand.
That equals $2,475 Chipotle burritos.
Yes, you heard me correctly.
You would pay more in fees than that initial $10,000
that you invested.
I don't know about you,
but I wouldn't be willing to give up
over 6.5 years worth of daily Chipotle burritos
for them to do something as simple
as put me into a three fund portfolio.
They wanna make it as complicated as possible
to make it appear like
they're doing something productive with your money
by constantly fiddling with your portfolio
to justify charging you 1%.
If they knew that you knew
that it was as easy as buying three low cost index funds,
then they'd be out of a job,
which is why you most likely
only hear this sort of good advice
from a fiduciary financial advisor
because they are legally obligated
to act in your best interest.
And the trust worthy ones usually only charge a flat fee
as opposed to an ongoing yearly fee.
Not all non-fiduciary financial advisors
are professional scumbags,
but we do have to acknowledge the fact
that their incentives aren't aligned
with helping you make the best investment decisions.
Investing in a three fund portfolio
reduces the amount of time
that you need to spend with and pay a financial advisor
whose goals aren't aligned with yours.
But avoiding a shotty advisor
isn't the only reason to use a three fund portfolio.
It's also a good way to avoid the risk
that comes from an active fund manager
that's handling how money's invested
within a mutual fund that you invest in.
Low cost total stock market index funds
held within a three fund portfolio
are passively managed funds,
which means that they funds managers
aren't choosing what to buy, sell and hold.
Actively managed funds on the other hand,
are run by people who are choosing which stocks
to buy, sell and hold.
To successfully pick the right stock combo
to outperform a basic total stock market index fund,
these fund managers need to have some level of skill
to achieve that out performance.
But time after time the data shows
that it's nearly impossible to successfully do this
over long periods of time.
The hot fund manager everyone talks about today
turns out to be the loser of tomorrow
that everyone eventually forgets about.
In a paper published in the journal of finance
called luck versus skill
in the cross section of mutual fund returns,
Fama and French found that "On a practical level
"our results on long term performance
"say that true out performance
"and net returns to investors
"is negative for most if not all active funds."
In the paper they did admit
that when returns are measured before costs
and expense ratios there is stronger evidence
of manager skill,
but this is irrelevant though
because you're not getting into these funds
without paying a fee.
It's like saying I have this awesome new electric car
but there's nowhere for me to charge the thing
so I can't really turn it on and drive it.
All I can do is look at it.
- Look at that, that's nice and shiny.
- Which brings up another advantage
that the three fund portfolio has.
The three index funds that make up the portfolio
are extremely low cost.
The price for each can vary from fund to fund,
which we'll cover in just a minute,
but compared to most other funds out there,
they're the lowest since they're passively managed.
For example, the Vanguard ETF versions
have an expense ratio of 0.03%,
0.08% and 0.035%.
That means for every $10,000 invested
you're paying an expense of $3, $8
and $3.50 per year.
A study from the Financial Research Corporation
called Predicting Mutual Fund Performance
set out to determine if there were any ways
to predict the future performance of a mutual fund.
They tested 10 different predictors
like past performance, morning star ratings,
expenses, turn over, manager tenure,
asset size and a few more things.
They came to the conclusion that the best way
to reliably predict the future performance of funds
was by looking at the expense ratio
and nothing else.
They call a favorable expense ratio
an exceptional predictor for bonds,
and a good predictor for stock funds.
Based on this research,
if you wanna pick a successful fund,
then ignore everything else,
and just look for the one
with the lowest expense ratio.
And lucky for the three fund portfolio,
those three total stock market index funds
are about as low cost as they get.
Hang tight because I did all of the legwork for you
by putting together a list
of the exact tickers that you might wanna use.
I'll cover those in just a minute.
It was cold in here,
and now it's hot,
so the jacket had to come off.
When it's all said and done,
the biggest selling point
of a three fund portfolio is that it's just easy.
Literally dummy proof.
Contributing money to your investment account
on a regular basis,
and spreading that money among only three funds is easy.
Rebalancing once per year across only three funds
is easy.
When it comes to withdrawing money when you're older,
you only have to pick between three funds to sell off,
which is easy.
When choosing what to invest in,
you only have three funds to worry about,
which is easy.
Investing isn't complicated at all,
but for some reason we like to make it out to be
more than it actually is.
There is zero correlation between
spending a bunch of time
trying to pick stocks or mutual funds,
or spending a bunch of money on an advisor,
and an increase in your investment returns.
Successful investing has more to do with your psychology
than anything.
Stick with the three fund portfolio process,
and get on with living your life
because the returns will take care of themselves.
The first step in building your three fund portfolio
will be to choose the three funds that you'd wanna use.
Here's a list of the exact funds that you'd wanna hold
deponing on which investing platform that you use.
All you do is choose one from the total U.S. funds,
one of the total international funds,
and one of the total U.S. bond funds.
Side note, if you're building this portfolio
within a 401k, then you might not
have access to a total U.S. stock market fund.
Now if that's the case,
then you should have access
to some sort of S&P 500 fund,
which you can substitute in its place.
You don't have to,
but I'd suggest choosing funds from the same row
just to make things a lot easier for you.
As you can see, all the funds are exclusive
to their respective investing platforms
except for the Vanguard ETF versions.
Those Vanguard ETF's can be purchased
on any investment platform,
which is why they're my number one choice.
To the far left, you can also see
that I've ranked each three fund mix.
I did that because the more that I looked into each one,
the more I realized that they are not all created equally.
Even though the expense ratios for each fund
within a category is going to be different,
they're not far off enough to where I'd steer you
away from any of them.
The issue I have is that when the name of a fund
says total U.S. stock market index,
I would assume that the fund
would hold literally every single stock on the U.S. market.
The same goes for the total international
and total bond index as well.
But the more I started to look into each one,
the more I realized that that's far from accurate.
Most of these funds do not actually hold,
quote, unquote, everything.
Here's the same list,
and next to each ticker symbol
I have how many stocks or bonds
are held within each one.
Based on this info,
the only true U.S. stock, international stock,
and bond funds are the ones offered by Vanguard.
That's not to say that you should avoid any of the others,
but it's something to be aware of.
The returns will most likely be
pretty close between all of them,
but if you wanna get the closest return
to the market as possible,
then go with the Vanguard funds.
Once again, the good news is that with the Vanguard ETFs,
they can be purchased on any investment platform out there.
The next step will be to choose an asset allocation.
Meaning out of 100%, how much should go towards each
of the three funds.
This is quite possibly the most important decision
that you'll have to make, so pay attention,
because it's going to have a direct impact
on your expected return
and risk level.
The more risk you wanna take,
for example, the more stocks
and less bonds that you wanna hold,
the higher expected return.
The inverse is also true.
So the less risk that you wanna take,
i.e., the more bonds and less stocks,
the lower expected return.
Here's a chart I put together
showing you how different stock
and bond allocations would have performed
over the past 34 years.
On the first line,
the 0% stock and 100% bond allocation
would have only netted you
an average of 5.73% annual return.
During the worst year,
you would have only lost 2.66%,
with a max draw down of 5.96%.
On the last line,
I tested a 100% stock
and 0% bond allocation for 34 years.
It gave us an average annual return
of basically 10%.
But, and this is a big but,
you would have had to been able
to handle a worst year return of negative 38%,
and a max draw down of negative 52%.
That means that if you had a million dollar portfolio,
and you were 100% in stocks,
that at one point you would have
been down $520,000,
and your three fund portfolio would be worth $480,000.
Yes, of course your investments eventually recovered,
but you need to ask yourself
if you could handle that kind of draw down on your portfolio
and not panic sell.
That point when the portfolio was down 52%
was the housing market crash,
which started towards the end of 2007.
There were a lot of unknowns during that time.
And looking back on it now,
we know how things played out.
But if you were in the middle of it,
then you had zero clue
if the whole financial system was going to crash.
To make things even worse,
your portfolio during that time
would have been under water
for a little over five years and two months.
Let me say that again in a different way.
It would have taken your portfolio
1,885 days to fully recover
from that $520,000 loss.
So you need to ask yourself could you handle not selling
and continuing to invest during that time
if you were invested in 100% stocks,
because to get that 10% average annual return
over those 34 years,
you would have had to of not sold,
and continued to invest money every single month,
even when it looked like there wasn't any light
at the end of that tunnel.
That's one of the prices that you have to pay
for that higher average annual return.
Always keep that in mind.
And I didn't even put in here data
of other times it crashed too
because that wasn't the only time.
There was another time where I think it was down
43% or 48% as well.
Based on the odds and history,
we know that it's likely your portfolio will tank,
potentially like that,
at some point between now
and when you disappear from this earth.
If you want your money to grow in a meaningful way,
then you have to have a decent amount
of your money invested into stocks,
which means that times like these
are going to hurt no matter what.
If you don't think that you can
handle huge swings like that,
but still wanna give your money
a fighting chance to grow,
then start with a five, 10 or 20% bond allocation
within your three fund portfolio.
You're also going to wanna continue investing
even when times look really, really ugly
in the economy and the stock market.
When it comes to how much to put
towards international stocks,
this is a tricky one that's been debated
so many times.
And because of that I refer back to Jack Bogel,
the founder of Vanguard on this one.
For a long time he was completely against
allocating any money towards international stocks.
His thought process was that if you already own
a total U.S. stock market index,
then you naturally have exposure to international markets
because a lot of those corporations
do a ton of business overseas.
But as time went on he changed his stance a little bit.
He ended up saying that he would be fine
if someone held anywhere
between 0% and 20% of their portfolio
in international stocks.
So do what you want with that info.
If you're really not sure,
then start out with something like 10% in international,
and then adjust it up or down from there.
When it comes to rebalancing your portfolio
to get your allocations back to where they should be,
I would only plan on doing that once per year.
Don't worry about doing it any more than that.
One of my favorite investing platforms that I use,
and I love that makes
the whole three fund portfolio investing
a lot easier is M1 Finance.
I'll have a link in the description
of this video to check them out,
and also get a free $30 from them.
Now it's time to implement this strategy for yourself.
If you have any additional questions
beyond what I've covered so far,
please leave them down in the comments below,
and I will try to answer every single one of them for you.
But there's two things
that I really need to stress to you though.
Number one, it is extremely important
to invest money into this type of portfolio
on a regular basis.
Consistency is key.
The returns I showed you,
are all what happened in the past,
and do not give us any indication
of how things will play out in the future.
For all we know,
the returns for everything going forward
might be lower.
Now if that's the case,
then the best thing that you can do
is to shove as much money as possible
into those investments on a regular basis.
The returns on a 100% stock portfolio
might only net you an annual return of 5%
as opposed to that 10% that we saw.
But I would rather be earning 5% on a portfolio
of $800,000 than one that's only worth $400,000
because I wasn't investing on a consistent basis.
And number two, there's going to come a time,
most likely multiple times,
when things look very dark and grim within the world,
the economy and the stock market.
I am talking really, really ugly.
Kind of like when we were in the middle
of the housing market crash of 2008.
I need you to ignore all of that noise,
continue to invest,
stay optimistic, don't fiddle with this portfolio,
and stay the course.
Corrections and bear markets will come and go.
But I can promise you one thing,
if your three fund portfolio is crashing,
then everyone else's most likely are as well.
But the only people who actually lose money
are the ones who sell
or start messing with their portfolios during that time
because they're the ones who are locking in their losses
by doing those things.
I've met a few people who sold their investments
at the bottom of the housing market crash,
and still haven't fully
put their money back into the market.
Now those people had to push out their retirement dates
another 10 and 15 years because of that panicked decision.
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before you go.
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finance and investing needs.
I'll see you in the next one friends.
Done.