- I spent a whole video
talking up the three-fund portfolio
and going on and on about how it's the king.
While I still believe it to be true,
I should have put a little Barry Bonds asterisks
by that statement
because there's a portfolio that I like a lot more.
85% of my viewers are over the age of 25
so hopefully that reference wasn't too obscure.
The portfolio that's a good alternative
to a three-fund portfolio is the two-fund portfolio.
So let's talk about why that is
and when it might make sense to use it.
As a little bonus, I'll also answer the question
of when it does and doesn't make sense to rebalance
either of these portfolios.
Think of the two and three-fund portfolio like co-emperors.
One of the emperors would run the show
under certain conditions,
and the second emperor would run the show
under other conditions,
kind of like when the more reserved, stoic Marcus Aurelius
and his younger, more aggressive brother, Lucius
ruled Rome at the same time.
I say that one is a more aggressive portfolio,
while the other is more reserved
because the assets that are held within each one.
The three-fund portfolio is made up of a total US stock
or S&P 500 index, a total international stock index,
and a total US bond index as well,
while a two-fund portfolio only holds two of those three,
the total US stock or S&P 500 index
and total international stock index.
Of course, more stock-based funds
equals a more aggressive portfolio.
Here's an easy list of potential three-fund portfolios
from Vanguard, Charles Schwab and Fidelity.
If we're talking about the two-fund portfolio,
then all you do is hack off the bond index fund
from that list.
Bonds are the only thing
that makes these two funds different.
I know, I know, some of you may be thinking
with interest rates and inflation on the rise,
bonds are absolute trash,
so there's no reason to hold any of those things.
Wrong, wrong, and wrong.
Yes, rising interest rates are bad for bonds.
Yes, high inflation is bad for bonds.
But they still make sense to hold
within a three-fund portfolio,
and we'll cover why that is later in this video.
Even though the two and three-fund portfolios
are very different, they have quite a few shared benefits.
The first is that the stock portion of both
hold a total of 11,768 stocks
for companies spread across the world.
This instantly diversifies your money
among different companies, sectors, countries,
and even currencies.
You might come across headlines
about how diversification can be an investor's worst enemy,
but in reality, it's going to reduce your risk
of being overexposed
to any of the different factors that I just mentioned.
Because you have one US stock fund
to handle the companies based there,
and one international stock fund
to handle the rest of the globe,
there is zero portfolio overlap.
Portfolio overlap happens when you invest in multiple funds
that holds the exact same stocks.
Having too much fund overlap
can reduce your diversification,
and it isn't so obvious
if you hold a buttload of random funds
that hold too many stocks for you to keep track of.
Before you try to cancel me,
yes, a buttload is in fact, a real unit of measure.
So get your mind out of the gutter, you freaks.
Even if it wasn't, I'd probably still use the phrase
because a buttload has a nice ring to it.
A simple example of portfolio overlap
would be if you held something
like the Vanguard Total Stock Market ETF
and the Vanguard S&P 500 ETF at the same time.
Since the total US stock ETF
holds literally all of the stocks within the US,
the 500 stocks that are held
within the S&P 500 are going to already be in VTI.
This would cause a 99% overlap
of VOO'S holdings within VTIs holdings.
Therefore, it doesn't really make sense
to hold both of these funds at the same time,
because you just end up concentrating more money
into those 500 companies without even realizing it.
Time out though because I need to give a quick disclaimer
about what I just said.
This exact example is probably the least problematic
because having more money in those top 500 stocks
isn't going to destroy your diversification.
It was the simplest and most straightforward example
to get my point across.
If you have a choice, then pick one or the other.
But if you invested in both, then you'll be perfectly fine.
Portfolio overlap is more problematic
when we're talking about holding a fund
like the Vanguard S&P 500 ETF
and the Vanguard Growth Index ETF.
That's because 65% of VUG'sholdings
are already held within VOO, which is pretty darn high.
If you invested in both,
then you'd have more money allocated
to those 166 overlapping stocks.
I'll have my VTI versus VOO video
linked at the end of this video
and in the description as well.
But of course, wait until the end of this video
before watching it, because we need to talk about
saving some money on your investments.
If you're enjoying this video so far,
then help support my dog, Molly,
who is actually laying at my feet right now,
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Like I said, it does help support her
as well as this channel.
Both the two and three-fund portfolios
are extremely cost-effective as well.
For every $1,000 invested into the Vanguard ETF versions,
you'd only pay 30 cents every year
for the total US stock index
and 80 cents for the total international stock index.
Compare that to the $7.50 you'd pay per year
for every $1,000 invested
into an expensive actively managed fund like ARKK.
Even though I usually don't do public math,
I'll make an exception for you right now.
A Vanguard Total Stock Market ETF is 25 times less expensive
than the actively managed fund that charges 0.75% per year.
Because these two and three-fund portfolios
track an underlying index,
they're not relying on a fund manager
to successfully buy and sell stocks
that are held within the fund.
This immediately reduces the fund manager risk
associated with actively managed funds.
Any professional investor is trying to outperform one thing,
a benchmarked index.
Now, this could be something like the S&P 500
or the total stock market index,
but a fund manager can't do that
without taking on additional levels of risk.
A good example of fund manager risk
is the psychopath fund manager
that runs the ARKK investment funds, Kathy Wood.
Now, I'm sure on a personal level, she is a very nice gal,
but on a professional level, she is a big time swindler.
At one point, she said that her fund
would deliver a 40% compound annual rate of return
during the next five years.
Her fund is already down around 40% this year.
So if she wants to hit that average 40% per year,
she's got a lot of catching up to do.
When someone claims they can get you this type of return,
you should run for the hills
because that's not only delusional to think,
but even more arrogant to say out loud
for the world to hear.
That claim is the definition of a red flag,
just like an ex-girlfriend
secretly stealing a pair of my house keys
was a red flag as well.
Wait, because we have breaking news,
Kathy Wood actually upped the ante.
She said she's now estimating her future annual returns
at 50%.
This means, she's saying that if you invest $10,000
into one of her funds, then in five years,
that'll grow to $76,000.
That is insanely stupid.
If something sounds too good to be true,
then it probably is.
Avoiding fund manager risk like this
is what you're trying to avoid
by investing in something like
a two and three-fund portfolio.
The two and three-fund portfolios
are kind of like the Raising Cane's
of fast food restaurants.
If you've never been,
they offer four items and nothing else.
Boneless fried chicken, crinkle cut fries, coleslaw,
Texas toast, and their Cane's sauce.
Less decisions makes everything so much easier.
Rebalancing for both portfolios is simple.
Allocating money across those small amounts of funds
is simple.
Withdrawing money from a couple of funds is simple.
And removing all decision-making
when it comes to what to invest in is simple.
There's no reason to pay an expensive financial advisor
an ongoing 1% fee every single year
to manage a two or three-fund portfolio.
Simplifying things out days is underappreciated,
but it makes everything less stressful,
increases efficiency, and frees up your time.
The only thing that makes these different
is that the three-fund portfolio has an allocation
to a bond fund, while the two-fund portfolio does not.
Some of the most ignorant comments I've heard
over the past couple of months
in the comment sections of my videos is that bonds are dead
so you shouldn't own them.
Because interest rates have increased
and we expect them to continue,
bonds are in a have bad place right now
because that causes their value to go down.
To top it off, inflation is crazy high right now at 8.5%.
This means if your bonds are only returning 2.5%
and inflation is 8.5%,
then you're getting a negative 6% real rate of return
on your money.
On the surface and looking at it in this snapshot of time,
yeah, that's bad.
But two things I need to mention
to defend the bond portion of a three-fund portfolio
before I tell you when not to use it.
Number one, our mindset needs to be the same with bonds
as it is with how we think about investing
in stock-based index funds.
As a longterm buy and hold investor,
what's happening to our investments
in the short term is irrelevant.
From January, 1988 through November, 2020,
whenever monthly equity returns were down,
monthly bond returns remained positive
about 71% of the time.
Based on current returns,
investing in bonds might not look appealing right now,
but always remember that we're investing
for decades and not days.
Number two, bonds still serve the same purpose
in a portfolio, to reduce volatility
from the stock-based index funds that we hold.
Where else are you gonna put that money to replace bonds?
Are you gonna speculate by putting it into gold
or how about cash
where it's guaranteed to eaten away by inflation?
It doesn't make sense
to throw the money into dividend stocks either
because those are tied to the stock market volatility,
just as much as your index funds.
And don't even get me started by saying
that Bitcoin can replace bonds,
like some people have in the comment sections of my videos.
Bitcoin is more volatile than stocks,
which is where you definitely don't wanna
put your bond allocation.
If you have an allocation to bonds, then stay the course
and ignore the noise.
People like us don't freak out about things like this.
We sit back and we remind ourselves how in 10 years
we're gonna look back at this point in time
and laugh at how the irrational people were flipping out
and running around with their hands in the air
like the sky is falling.
- Run for your lives!
Everyone, run for cover!
You're all in danger!
- As much as I just talked up bonds
within a three-fund portfolio,
I'm about to do a 180 and say that if you're younger,
then a two-fund portfolio
could make a lot more sense to use.
Insert another Barry Bonds asterisks right there.
The younger you are,
the more stock market volatility is your friend.
By younger, I'm talking seven plus years
away from needing the money to live off of.
I'm personally not a huge fan
of putting any money into bonds
as long as you're in the accumulation phase of investing,
because doing that
is going to limit the upside of your investment returns.
Investing in a simple two-fund portfolio
made up of a US stock fund and international stock fund,
then eventually transitioning into a three-fund portfolio
later down the line is more ideal.
That being said, if you're someone who is younger
and feels comfortable having a little bit of money
allocated to bonds
because it fits your investment behavior a lot better,
then there's nothing wrong with that.
Is it ideal from a return perspective?
Absolutely not.
But the more important thing is to build a portfolio
that we can emotionally hang onto
during the good and bad times.
One question that's always been up in the air for me
is whether or not it makes sense
to rebalance a two or three-fund portfolio.
I always thought it made sense to do
because you wanna stay as close as possible
to your stock and bond allocation.
Then I heard Jack Bogle, the founder of Vanguard
share his thoughts on it.
- But having some stability
without automatically rebalancing,
I don't think you need to do that,
but the less you rebalance, the more you're gonna have,
because you're always selling the better performing asset.
- I am a huge fan of Jack Bogle
because of what he did for average investors like us.
I even have a tattoo of his face on my head.
You just can't see it 'cause I have hair right now.
But I wanted to see if what he said held up
based on back testing, rebalancing
versus not rebalancing a two and three-fund portfolio.
Quick disclaimer before I show you the results,
these past returns don't mean things will play out this way
going forward.
It's just a way to give you something to think about
when evaluating the decision for yourself.
Here are the stock and bond allocations
I used in the back test.
Changing any of these would change the results
so keep that in mind.
For each portfolio, I invested $500 per month,
adjusted for inflation,
and ran it from 1987 through the end of 2021.
Rebalancing annually, the three-fund portfolio
ended with a value of $2,092,000
and a 9.75% annualized return.
The two-fund portfolio ended with a value of $2,297,000
and a 10.15% annualized return.
Not too bad of an outcome for either one.
I'd personally be pretty happy with both of those results.
Now, let's test Jack Bogle's suggestion
of not rebalancing the portfolios.
Since contributions are being made monthly,
anytime the two or three-fund portfolios
move away from our target allocations,
the contributions will be invested
in the ones that are underweight
to get them back up to where they need to be.
If you think about it,
this is technically a form of rebalancing,
but just not in the traditional sense of the term.
Not doing a additional rebalance,
the three-fund portfolio would've ended
with a balance of $2,373,000
and a 10.16% annualized return.
For the two-fund portfolio,
the ending balance would be $2,535,000
with a 10.48% annualized return.
Here's a quick side by side
of the two and three-fund portfolios.
And it looks like Jack Bogle has been right so far.
But going forward, who actually knows what's gonna happen.
Either way, it's probably not gonna make or break
your returns over the long run
while you're still contributing money every single month.
If you hold these funds in a taxable account,
then it probably doesn't make sense to do any rebalancing,
because when you sell off your winners to buy your losers,
you're going to pay capital gains taxes
so I'd probably avoid it in this type of account.
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Done.