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How Investment Fees Affect Wealth

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Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

It costs money to invest. We pay all types of fees, some obvious, some not so obvious. In this article I'm going to walk through the most common investing fees you are likely to encounter. Then we'll examine just how destructive a seemingly small amount of fees can be to your wealth and retirement.

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Do Fees Really Matter?

Before looking at specific types of investment fees, let's first ask whether fees really matter. To answer that question, the first thing we must recognize is that seemingly small fees, over time, can seriously reduce the value of an investment portfolio.

The Securities and Exchange Commission (SEC) published a paper on this very topic in 2014. It noted that “fees may seem small, but over time they can have a major impact on your investment portfolio.”

Invest fees affect on a portfolio over 20 years

Some have argued that fees don't matter. Instead, what matters are returns after factoring in the fees. In other words, paying high fees is not only fine, but ideal, if the investment returns enough to justify the fees. Conceptually this makes sense. In practice, however, it falls apart.

Study after study after study shows that expensive investments underperform inexpensive investments. For example, Vanguard looked at the annualized returns for a 10 year period ending December 31, 2014 for two groups of mutual funds: 25% of the funds with the lowest expense ratio and 25% with the highest. The low-cost funds won.

Funds with lower costs outperform more expense ones

The primary way we keep fees down, as we'll discuss more below, is to use low-cost index ETFs and mutual funds. It's an approach Warren Buffett, the CEO of Berkshire Hathaway and arguable the best investor alive today, supports:

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. . . . My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

Types of Investment Fees

There are countless fees investors may encounter. I'm going to list them in the order you are more likely to encounter them. Some fees are virtually unavoidable, but can be kept to a minimum. Other fees should be avoided at virtually all costs. Frankly, the only fee that is truly unavoidable is the first one on our list–expense ratio.

Expense Ratio

Mutual funds and ETFs charge investors a fee. The fee covers the cost of the fund, including payroll, as well as profit for the fund company. Expense ratios are expressed as a percentage. For example, a fund that charges a one percent (1%) expense ratio would cost an investor 1% of the amount invested in the fund (e.g., $100,000 investment would cost $1,000 per year with a 1% expense ratio).

The expense ratio is practically unavoidable. Fidelity does offer a few funds with no expense ratio, but that's the exception. Even low-cost fund provider Vanguard charges expense ratios on its ETFs and mutual funds.

Transaction Costs

There can be costs to buy and sell stocks, mutual funds and ETFs. By and large these costs are easy to avoid. Most mutual fund companies and brokers have gone to $0 trades if made online. There is, however, one important exception.

Many brokers charge a commission when you purchase a mutual fund (not an ETF). For example, I have an account at Merrill Edge, and the broker charges $19.95 when I purchase certain mutual funds. They do have a list of fee-free funds, but many of the funds I use from Vanguard would require payment of the commission.

For this reason, it's important to understand the types of investments you want to make before choosing a broker. If you know, for example, that you'll invest entirely in Vanguard funds, it makes sense to open an account at Vanguard or a broker that offers at a minimum free Vanguard ETFs. M1 Finance is a good example and a broker I also use.

Investment Advisor Fees

Advisor fees come in two forms: (1) a percentage of assets under management (AUM), or (2) a fixed or hourly fee. The vast majority of advisors charge a percentage of AUM, with 1% the industry standard (although fees do vary based on account size and services provided).

Some lower cost AUM advisors have entered the market over the past 10 years or so. Vanguard offers advisory services for just 30 basis points. A number of so called robo-advisors offer their services for about 25 basis points (e.g., Betterment and Wealthfront).

A growing list of advisors have turned to hourly or fixed fees. These arrangements almost always favor the client, as the total cost is generally far less than the AUM model. One such advisor is Mark Zoril of PlanVision.

As you'll see in a minute, Advisor fees based on a percentage of AUM destroy more wealth than any other fee (although high expense ratios are a close second).

Load Fees

Some mutual funds charge what are called load fees. Front-end load fees are paid when you invest in a mutual fund with this type of fee; Back-end load fees when you sell.

Front-end load fees typically cost 5.75%. For every $100 invested, fees take $5.75, leaving $94.25 in your account. There's absolutely no reason to invest in mutual funds that charge load fees. Ever!

Where to Find the Expense Ratio of a Mutual Fund

There are several easy ways to find the expense ratio of any mutual fund or ETF. For starts, you can Google the ticker symbol of the fund. VSTAX, for example, is Vanguards total stock market fund. Searching “VSTAX” returns the following result, including the fund's expense ratio:

How to find expense ratio using Google
(The Expense Ratio of 0.04% is in the bottom right of the image)

You can also see if a fund charges a load fee AGTHX, an American Funds growth fund:

how to find load fees
Note the “Front load” of 5.75%

Another free tool that tracks both the expense ratio as well as any load fees is Morningstar. You can also check the prospectus of the funed.

As for investment advisor fees, you should ask. It's as simple as that. It should also be reflected on your statements. You can also find fee disclosures in the advisor's Form ADV. But asking is much easier.

How to Determine the Expense Ratio of Your Investment Portfolio

While it's important to know the expense ratio of each investment, what really matters is the overall expense ratio of your portfolio. You could calculate this by hand. Just take the weighted average of your expense ratios across all of your investments. If that sounds as inviting as a root canal, there is an easier way. Use Empower.

Empower is a free financial dashboard. Link all your financial accounts (checking, savings, credit cards, retirement accounts, HSAs, loans, taxable investments) and Empower provides a wealth of tools. You can do everything from budgeting to loan payoff to retirement planning. And for our purposes, it will automatically calculate the expense ratio of your investment portfolio.

Here's the results from a demo portfolio I entered into Empower:

Empower Investment Fee Analyzer

Note the 0.10% annual fee to the right. That's the expense ratio of a portfolio that included dozens of investments. You can read my review of Empower or go directly to its free signup page (truly free-no credit card needed–ever).

How Fees Affect Your Wealth

Let's imagine that we make the maximum contribution to an IRA ($6,000) during our working years from age 20 to 65. If we earn an average of a 9% return on our investments, we'll retire with about $3.1 million (gotta love compounding).

Now let's assume we pay an investment advisor a “small” 1% fee. Our retirement fund drops to $2.3 million. Add in a 1% expense ratio on the mutual funds, and our nest egg falls further to $1.7 million. Yeah, fees matter.

How to Avoid Most Investment Fees

There are several important steps to take to keep you fees low.

Low cost index funds: First, stick to low cost index funds (ETFs or mutual funds). They outperform the vast majority of actively managed funds over time. There are plenty of sound “lazy portfolios” that make for great long-term investment strategies. Here are a few of them:

Avoid Expensive Advisors: There's simply no good reason to pay more than about 0.30% of AUM, at the most. Vanguard offers its services at this price. Why pay more? And there are plenty of advisors who charged by the hour, which is even better.

Consider Automated Investment Services: For those that want a little help, you can consider a robo advisor. They come in all shapes and sizes. I like Betterment and Wealthfront for those who want a set-it-and-forget-it arrangement. Cost is about 25 basis points. For those who want more control, M1 Finance is the way to go. It lets you create your own mutual fund (they call them Pies). It's easy to use, easy to rebalance, and free.

The Paul Merriman Ultimate Buy and Hold Portfolio

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I first met Paul Merriman back in 2017. He was kind enough to come on my podcast to talk about what he calls the Ultimate Buy and Hold Portfolio. We’ve kept in touch over the years, and in fact we were just talking about a month ago. In this article we’ll dig into the details of his investing strategy.

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Who is Paul Merriman?

Paul Merriman

Paul founded an investment advisory firm back in 1983. He retired in 2012, and in 2013 he started the Merriman Financial Education Foundation where he helps educate investors. He's also published several books, including his most recent one, We're Talking Millions!: 12 Simple Ways To Supercharge Your Retirement.

Over the years he’s developed what he calls the Ultimate Buy and Hold Portfolio. As you’ll see, it consists of 10 stock asset classes, each implemented with a low cost index mutual fund or ETF.

The Ultimate Buy and Hold Portfolio

Stocks

There are several versions of Paul's Ultimate Buy and Hold Portfolio. We'll spend most of our time looking at the version that has become famous over the years. It consists of the following 10 stock asset classes:

  • S&P 500
  • U.S. Large Cap Value (LCV)
  • U.S. Small Cap Blend (SCB)
  • U.S. Small Cap Value (SCV)
  • Real Estate Investment Trust (REIT)
  • International Large Cap Blend (LCB)
  • International LCV
  • International SCB
  • International SCV
  • Emerging Markets

Paul allocates the equity portion of a portfolio equally across these asset classes. For example, a portfolio of 100% stocks would see 10% allocated to each asset class. An 80/20 portfolio would have 8% allocated to each class, with 20% going to one or more bond funds (we'll look at examples in a moment, but you can check out Paul's portfolio implemented as a 80/20 portfolio on M1 Finance.)

Bonds

Merriman recommends three types of bonds for the fixed income portion of his strategy:

  • Intermediate term Treasury bonds (50% of total bonds)
  • Short term Treasury bonds and bills (30%)
  • Short term TIPS (20%)

I agree with much of what he suggests. He's avoided high-risk bonds such as those issued from emerging market governments or troubled corporations. He's also kept to a shorter yield curve and added some exposure to inflation protected securities.

If there's any aspect I might adjust it's to add more TIPS. If you believe inflation will be higher in the future than the market is predicting, TIPS are a way to place that bet. In contrast, if you think inflation will be lower than expected, Treasury bonds are the answer.

For those like me who have absolutely no idea, you split your bond portfolio equally between the two. That's exactly what the David Swensen Portfolio does. The only caveat today is that TIPS start with a negative yield, and if you're like me, that's a hard pill to swallow. Nevertheless, that's how I've implemented the Ultimate Buy and Hold strategy in M1 Finance.

How the Ultimate Buy and Hold Portfolio is Different

There are several aspects to note about Merriman's investing strategy:

International Exposure: The portfolio allocates a full 50% of equities to international funds. This is unique among the portfolio's I've evaluated. Most are less than 50%. The Warren Buffett Portfolio doesn't allocate anything directly to international stocks. And Vanguard's founder, Jack Bogle, saw no need to own international stocks.

I personally think international exposure is important. My portfolio allocates about 30% to global funds.

Small Cap Exposure: The Ultimate Buy & Hold portfolio allocates 20% to small cap stocks. It does so because history tells us that small cap companies out perform large cap companies over the long term. Over the past 50 years, small cap has outperformed large cap by more than 1%. A $10,000 investment beginning in 1972 would grow to more than $2.7 million if invested in small companies, compared to $1.5 million in large companies.

Source: Portfolio Visualizer

Value Exposure: Finally, Merriman's strategy favors value investments over growth. Again, history tells the story. Although growth stocks have outperformed value recently, over the last 100 years, value has performed better in both large and small companies.

Historical Performance of the Ultimate Buy and Hold Strategy

The big question is how Merriman's Ultimate Buy and Hold portfolio has performed. As you can see in the chart below (click the image to enlarge it), the portfolio has trounced the S&P 500 over the last 50 years.

The portfolio has returned 12.4% annually compared to 10.7% for the S&P 500. Note, however, that it comes with more risk. The standard deviation of Merriman's portfolio, when rebalanced annually, weighs in at 18.5%, compared to 16.9% for the S&P 500. In other words, if you can handle the volatility, Merriman's portfolio may be a sound option. Note too that by rebalancing monthly, you decrease both the returns and volatility.

Before we leave the performance of this investing strategy, it's worth looking at how well it's done over the last decade. As you can see, the portfolio has lagged the S&P 500 since 2010:

Source: Portfolio Visualizer

Why? Over the last decade large companies have outperformed small companies, growth companies have outperformed value companies, and U.S. companies have outperformed international companies. In other words, in just about every way that the Buy and Hold portfolio overweights has seen underperformance.

Much of this is the result of a low inflation, and easy money policy of the Fed and federal government. Massive borrowing and spending has sent asset prices soaring, which favors larger growth companies.

I don't believe this undermines Merriman's portfolio. The U.S. can't borrow to infinity. But it does underscore that any investment strategy can lag the market for extended periods of time.

Building the UB&H Strategy

There are a number of ways to construct the Ultimate Buy & Hold Strategy. I've built one approach in M1 Finance using low cost index ETFs:

Keep a few things in mind. First, the above portfolio is 80% stocks and 20% bonds. One can easily change this to whatever stock/bond allocation is best to meet their investment goals.

Second, some of the chosen ETFs cover more than one asset class. For example, Vanguard's small-cap ETF (ticker: VB) includes mid-cap companies. I think this is a perfectly reasonable approach to the UB&H strategy, but one could easily substitute a micro-cap ETF (e.g, iShares Micro-Cap ETF IWC).

Here's what the asset allocation looks like in Personal Capital:

Finally, M1 Finance is ideal for this portfolio as it makes rebalancing easy. With M1, you can rebalance a portfolio with the click of a button.

The Simplified Ultimate Buy and Hold Portfolio Alternative

Paul Merriman and his team have released simplified versions of the UB&H portfolio. These are ideal for those who don't want to juggle 10 stock asset classes! He has both a 4-fund and a 2-fund solution.

Source: https://paulmerriman.com/4-fund-combo-latest-recommendations/

4-Fund Ultimate Buy and Hold Portfolio

The Merriman 4-Fund Portfolio (see it here at M1 Finance) consists of the following four asset classes:

  • LCB (S&P 500)
  • LCV
  • SCB
  • SCV

This portfolio's performance is similar to the 10-fund portfolio. It has averaged 13.8% over rolling 15-year periods since 1928. The S&P 500 has averaged just 11.0%.

2-Fund Ultimate Buy and Hold Portfolio

The 2-fund solution has performed even better. Its average performance over rolling 15-year periods is an amazing 14.5%. Here, however, some cautionary words.

The 2-fund portfolio bets everything on value investing. The two asset classes are SCV and LCV. In the short to medium term, this portfolio could significantly underperform the market, such as what the 3-fund portfolio seeks to replicate.

Final Thoughts

The 10-fund Ultimate Buy & Hold portfolio is an excellent way to potentially outperform the market without sacrificing diversification. It does, however, represent a more volatile approach to investing. Therefore, it's not for everyone. At the same time, one can modify the portfolio to better suit individual approaches to investing.

My Research for this Article

Ray Dalio All Weather Portfolio

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Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

The Ray Dalio All Weather Portfolio is designed to perform well in any economic cycle. Using risk parity to match asset classes to economic risk, the portfolio promises to perform well in any market with less volatility than traditional asset allocation models. In this article, we'll examine the portfolio to see if it should be part of our investment strategy.

Ray Dalio All Weather Portfolio

Resources and Tools Mentioned in this Article:

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Who is Ray Dalio?

Ray Dalio is a billionaire investor and hedge fund manager. Dalio founded Bridgewater Associates in 1975 and built it into the largest hedge fund in the world with $140 billion in assets under management. He is the author of Principles: Life and Work (2017). 

Dalio is a student of economic cycles. He recently produced a video describing how economic cycles work:

It's his view on economic cycles that informs his All Weather Portfolio.

The Ray Dalio All Weather Portfolio

The Bridgewater Associates All Weather Fund

The All Weather portfolio dates back to 1996. It was the product of analysis by Bridgewater's Bob Prince and Ray Dalio, among others. What they found is the economic cycles revolve around two things: Inflation/deflation and growth/contraction.

Source: https://www.bridgewater.com/research-and-insights/the-all-weather-story

As growth and inflation rise and fall, different asset classes either rise and fall. The goal of the All Weather portfolio was to gain exposure in roughly equal percentages of the various asset classes that perform well in each quadrant. At Bridgewater, the result was the following:

  • EM Credit: Emerging Market Debt
  • IL Bonds: Inflation-linked bonds (Tips, I Bonds)
  • Nominal Bonds: Bonds not linked to inflation (e.g., Treasury bonds)

Unlike a traditional asset allocation, the All Weather portfolio allocates just 25% or thereabouts to equities. The rest of the portfolio goes to various bonds and commodities, including gold. In this regard, in stands in sharp contrast to the 3-Fund Portfolio and the Warren Buffett Portfolio.

The above portfolio at Bridewater was available to corporate clients and pension funds. It was not available to the average investor, until recently.

The All Weather Portfolio

In 2016 Tony Robbins published Money Master the Game: 7 Simple Steps to Financial Freedom. For the book Robbins interviewed Dalio, who outlined the All Weather Portfolio in a way that average investors could mimic.

The portfolio consisted of the following asset classes:

  • 30% Stocks
  • 40% Long-Term Bonds
  • 15% Intermediate-Term Bonds
  • 7.5% Gold
  • 7.5% Commodities

According to Tony Robbins, here are the performance metrics for the portfolio from 1984 to 2013:

  • 9.7% annual returns
  • You would have made money 86% of the time
  • Average loss of just 1.9%
  • Worst loss was -3.9%
  • Volatility of 7.6%

The returns are remarkable given a volatility (standard deviation) of just 7.6%. By way of comparison, the S&P 500 has a standard deviation of more than 15%.

One way to implement this portfolio is to use the following ETFs:

  • VTI    30%
  • VGLT 40%
  • USCI  7.5%
  • GLD   7.5%
  • BIV     15%

I've created this portfolio in M1 Finance which you can check out here.

As noted earlier, this portfolio's asset allocation is anything but traditional. Here's a view of the allocation using Personal Capital's Asset Allocation Tool:

Ray Dalio Portfolio Asset Allocation
Read my Personal Capital Review for more details on this free investment tracking app.

Backtesting of this portfolio is limited due to the commodities ETF. Still, we can see that it performed reasonably well since 2011 as compared to the Bogleheads 3-Fund Portfolio (80/20 allocation):

Note that it was neck-in-neck with the 3-fund portfolio until the recent post-Covid shock bull market. What's noteworthy is that the Dalio portfolio's standard deviation is just 6.23%, compared to 11.05% for the 3-fund portfolio. This in turn explains in part a Sharpe Ratio and Sortino Ratio much higher than the 3-fund portfolio.

In other words, the Ray Dalio portfolio performed better than the 3-fund portfolio on a risk-adjusted basis. At the same time, one can't ignore that the 3-fund portfolio outperformed.

Long-term Bond Exposure

It's hard to ignore the portfolio's exposure to long bonds (and even intermediate term bonds) given current interest rates. If you believe that rates will rise, parking 40% of a portfolio in long-term bonds could be a recipe for disaster. Even Ray Dalio today questions why anybody would own bonds.

In his recent article, Why in the World Would You Own Bonds When…, Mr. Dalio described the economics of investing in bonds as stupid:

The economics of investing in bonds (and most financial assets) has become stupid.

He went on to explain why he believes bonds are in a bubble:

…If bond prices fall significantly that will produce significant losses for holders of them, which could encourage more selling. Bonds have been in a 40-year bull market that has rewarded those who were long and penalized those who were short, so the bull market has produced a large number of comfortable longs who haven’t gotten seriously stung by a price decline. That is one of the markers of a bubble.

Beyond the end of the 40-year bull run in bonds, Dalio goes so far as to say shorting bonds is a “relatively low-risk bet.”

If Dalio is right, and I believe he is, it calls into question the sustainability of the All Weather portfolio. Keep in mind that he recommended it to Tony Robbins in 2016. A lot has changed in the last five years.

2x Leveraged Ray Dalio Portfolio

It is worth asking whether it makes sense to used leveraged ETFs with the All Weather Portfolio. While I'm generally opposed to such measures, it's common in risk parity portfolios to see leverage deployed to offset the low risk (i.e., low volatility) that these portfolios generate. The idea is to bring the volatility of the portfolio back in line with traditional asset allocation models, while enjoying slightly higher returns.

Creating the portfolio is easy in M1 Finance using ProShares ETFs. Here's what it looks like:

2x Ray Dalio Leveraged All Weather Portfolio
Check out the portfolio at M1 Finance

Examining this portfolio in Portfolio Visualizer led to some interesting results. What follows is a comparison of this portfolio, the standard All Weather Portfolio, and a 3-fund portfolio using an 80/20 allocation:

It's not surprising that the leveraged portfolio (Portfolio #1) outperformed the unlevered portfolio (Portfolio #2). What is more interesting is that it trounced the 3-fund portfolio (Portfolio #3) on both a total return basis and a risk adjusted basis (see both the Sharpe and Sortino ratios).

Pros & Cons of the Ray Dalio All Weather Portfolio

In the final analysis, the Rad Dalio All Weather Portfolio has several pros and cons:

Pros

  • Easy to implement with ETFs
  • Volatility lower than a “traditional” portfolio
  • Sharpe and Sortino ratios higher than a “traditional” portfolio

Cons

  • May underperform a 3-fund portfolio unless leverage is used
  • 50%+ allocation to intermediate and long-term bonds not ideal in current interest rate environment
  • Exposure to commodities and gold can underperform for long periods of time.

The Warren Buffett Portfolio Any Investor Can Copy

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Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

Warren Buffett is best known as the CEO of Berkshire Hathaway and arguably the most successful investor of all time. What fewer people know is that he recommended a very simple portfolio that any investor can use. In fact, it requires just two mutual funds or ETFs. That's it. We'll look at this Warren Buffett Portfolio and how you can implement it in your 401k, IRA or taxable investment account.

2013 Berkshire Hathaway Letter

Every year Mr. Buffett writes a letter to the shareholders of Berkshire Hathaway (full disclosure, I own shares of Berkshire). His letters are a goldmine of investing wisdom. For our purposes, it's what he said in the 2013 letter that's so important.

He first noted how he and his business partner, Charlie Munger, have made a career out of analyzing businesses. Most investors, however, don't have this experience. As he said in the letter, most “investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.”

Not to worry. As Buffett noted, “I've got good news, the non professionals, the typical investor, don't need this skill.” He explained:

“In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

That gives as a glimpse into the Buffett Portfolio. Let's now take a deeper look at what he recommends.

The Warren Buffett Portfolio

The Warren Buffett Portfolio consists of just two investments. The first is an index fund that tracks the S&P 500. Buffett recommends putting 90% in an S&P 500 index fund. He specifically identifies Vanguard's S&P 500 index fund. Vanguard offers both a mutual fund (VFIAX) and ETF (VOO) version of this fund.

He recommends the other 10% of the portfolio go to a low cost index fund that invests in U.S. short term government bonds. Vanguard here too offers a mutual fund (VSBSX) and ETF (VGSH) version.

Although Buffett is famous for picking stocks, he has put this simple 2-fund portfolio to use. He has advised the trustees who will manage his wife's investments after his death to use this portfolio.

Warren believes the “trust's long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.” (Source: 2013 Berkshire Hathaway Letter to Shareholders, p. 20).

Now, that last part is important. He didn't say that this portfolio will do better than every other portfolio. He said it will do better than those who employ high fee managers.

What About International Stocks?

One glaring absence from the portfolio is an international stock fund. In fact, the lack of direct international exposure is what distinguishes Warren Buffet's portfolio from the Bogleheads' 3-Fund Portfolio. Buffett doesn't explain this aspect of the portfolio, but there are at least three plausible explanations.

First, while the S&P 500 index includes companies headquartered in the U.S., they do business across the world. Buy one measure, foreign sales among the 500 largest companies accounted for about 29% of their $12 trillion in total sales according to a recent report. As such, the S&P 500 has significant exposure to international markets.

Second, the regulatory and political framework in the U.S. is conducive to business investment. While far from perfect, regulations in the U.S. hold public companies to a higher standard of disclosure and internal controls.

Third, international funds have underperformed U.S. companies over the past four decades. There have been 10-year periods where international stocks have outperformed (2000 to 2009, for example). On the whole, however, they've served to hold back the performance of a portfolio, as we'll see in more detail next.

Performance

The performance of the Buffett Portfolio tracks closely the S&P 500. That's not surprising given that it has a 90% allocation to the index. Still, it's worth understanding how it has performed, particularly compared to other portfolios.

First, here's a chart from Stock Rover comparing the performance of the Warren Buffett Portfolio to the 3-Fund Portfolio. Both use a 90/10 stock to bond allocation. The 3-Fund Portfolio has a 50% weighting to U.S. total stock market and 40% to international equities.

It's not surprising that Buffet's portfolio has outperformed over the past 13+ years. U.S. stocks have outperformed international stocks.

Let's now compare these to portfolios going back to 1987. To do that, we'll use Portfolio Visualizer. I assumed a $10,000 initial investment and $500 monthly contributions, adjusted for inflation. Here are the results:

Portfolio #2, which is the Buffett Portfolio, significantly outperformed the 3-fund portfolio. The difference in the CAGR (compound annual growth rate) may not seem significant (17.43% vs 16.23%), but over time its impact is huge. What's amazing to me is that the standard deviation, a measure of volatility, is actually a bit lower in the Buffett portfolio, and the worst performing year actually hit the 3-fund portfolio harder.

In other words, the Warren Buffett Portfolio returned better results with less risk. Maybe the Oracle of Omaha knows something about investing after all.

The Warren Buffett Portfolio in Retirement

One important question is whether Buffett's portfolio is suitable for retirees. In all my research, I've never found an investment advisor who recommends a 90/10 portfolio once you enter retirement. And for me, such a portfolio is just too aggressive.

Nevertheless, there is research analyzing this very question. Professor Javier Estrada published a paper entitled, Buffett's Asset Allocation Advice: Take it . . . with a Twist. He examined Buffett's asset allocation from the perspective of a retiree. Specifically, he looked at different asset allocations using Warren Buffett's two funds, the S&P 500 and the short term government bonds.

He looked at portfolios ranging from 100% stocks all the way down to 30% stocks, with the rest in bonds. In total he evaluated 86 different retirement scenarios over rolling periods beginning in 1900. What he found was that out of those 86 retirement scenarios, three and a half percent failed. And by failure he meant that the retiree ran out of money before 30 years.

In his analysis, the only asset allocation that had no failure rate was the 60/40 portfolio. But all the allocations he examined did reasonably well, except when you got really low on equities, and then the failure rate jumps.

He further examined two “twists”, or modifications, one could make to Buffett's portfolio. Basically, the twists determine whether a retiree withdrawals from the stock or bond portion of the portfolio. Generally, when stocks are up you withdraw from the stock fund, when they are down you pull from the bond fund.

Here's his conclusion:

“Buffett’s asset allocation advice is sound and simple, and yet many retirees may balk at the thought of holding such an aggressive portfolio. If that is the case, the two twists considered here may help a little, but probably not enough. However, those retirees who find a 90/10 portfolio acceptable are likely to find that, with the unsubstantial additional effort of observing the performance of stocks and implementing the first twist discussed, they may improve the performance of their portfolios.”

M1 Finance

I've started using M1 Finance to invest our credit card rewards. Unlike many who spend their rewards on first class travel, we save and invest our credit card cash back. To date our balance is over $26,000. 

I've implemented the Buffett Portfolio in M1 Finance, and you can check it out here.

The Ultimate Investment Tracking Spreadsheet

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Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

Keeping tabs on your investments can be a headache. That's particularly true, if like me, you have a number of different accounts. While my favorite investment tracking app is Empower (previously called Personal Capital), another tool I use is a free investment tracking spreadsheet. 

Investment Tracking Spreadsheet
Investment Tracking Spreadsheet

I'm going to walk through the spreadsheet in this article and video (see below). You can get a free copy of the spreadsheet here. It's extremely easy to use and will help you track your investments, asset allocation and mutual fund fees. And as you'll see, it's a great tool when it comes to rebalancing your portfolio. 

It consists of three sheets–Asset Class, Holdings and Stocks.

Investment Holdings Spreadsheet

The first step in using the spreadsheet is the Holdings sheet. This is where you should start. The data that I have in here is just demo data. This is not my actual portfolio, though, I do own many of the mutual funds that are listed here. But this is where you start and you want to enter your portfolio. And you could include mutual funds, ETFs, stocks, whatever you'd like. 

Investment Spreadsheet
Investment Holdings Spreadsheet

The color coded cells in the columns for Account, Symbol (i.e., Ticker) and Shares are the cells where you need to enter information. All of the other cells contain calculated values based on the Ticker.

For each fund we need to designate an asset class (Category column). The drop-down contains most major asset classes, but you can add more. For example, you could add categories for REITs, emerging markets or small cap stocks. (The video below explains how to do this.) 

Next you'll enter the number of shares that you own for each investment. The spreadsheet pulls in the price using a Google Finance function, and the total value is then automatically calculated based on a simple formula. It works the same with the fund expense ratio. A Google Finance function pulls in the data and the weighted expense ratio is just a simple formula. 

Individual Stock Spreadsheet

The spreadsheet works with individual stock holdings as well. The original version of this spreadsheet, linked to above, contains a separate sheet for stocks. In the current version I use, I just incorporate them into the Holdings sheet. Google Finance functions pull in the same data for stocks as it does for mutual funds (except there's no mutual fund expense ratio).

In terms of asset allocation, you have two options. You can classify stocks just like we classify mutual funds. I could, for example, classify my holdings of Apple and Berkshire as US stocks. Alternatively, you could create a separate classification called Stocks and separate them from mutual funds and ETFs for purposes of asset allocation. That's what I've done because my Apple holdings have grown so much it skews my asset allocation plan (that's a good problem to have!). 

Asset Class Spreadsheet

Once you have all of your investments into the holdings sheet, we can then now go to the Asset Class tab. This is where the magic happens. There's a lot going on here and I want to walk through it for you. 

Asset Allocation Spreadsheet
Asset Allocation Spreadsheet

This is the target asset allocation that we're using in the spreadsheet. It's in the My Target column. You'll want to put in your own target asset allocation. If you add other categories beyond what I have in the spreadsheet, you'll want to add rows for each here. The best asset allocation for you is going to depend on your age, debt, investment goals, time horizon, risk tolerance, and other factors.

Once you have your target asset allocation, the sheet compares it to your actual allocation. Next you'll see the difference between the actual portfolio value and what the target is. Now you'll notice that some of these cells are red and some are white. Red cells mean that the difference between our target and actual allocation is greater than the Threshold we've defined in the next column.

As a general rule, I set the threshold for rebalancing at 20% of the allocation for each asset class. For example, an asset class with a 25% allocation would have a threshold of 5%. An asset class with a 10% allocation would have a 2% threshold. This is based on research by Dr. Gobind Daryanani, CFP (See Opportunistic Rebalancing: A New Paradigm for Wealth Managers, Journal of Financial Planning, January 2008).

The significance of the threshold is that once an asset class exceeds that threshold, it turns this cell red. Now it's up to you to rebalance your portfolio, always keeping tax consequences in mind. Of course, you can set the threshold to whatever you want. To help with rebalancing, I've added a column to my current spreadsheet to show the amount by which each asset class is over or under my target allocation.

Video

In this video I walk through how to use the spreadsheet. Keep in mind that I'm regularly updating the spreadsheet to add new features, so the current version may be slightly different than what you see in the video.

Final Thoughts

I use this investment tracking spreadsheet primarily to rebalance my portfolio. It's just much easier than any other stock tracking app. To monitor my asset allocation, investment fees, performance, and retirement goals, I rely on Empower, but there are several really good investment tracking apps available.

How to Build a Three Fund Portfolio

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Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

A three fund portfolio is a simple approach to investing that, as the name suggests, involves just three mutual funds or exchange-traded funds. In just three funds, an investor can build a diversified, low cost portfolio that's easy to manage.

3-fund portfolio
3-Fund Portfolio

Popularized by the Bogleheads, the three fund portfolio is one of several “Lazy Portfolios.”  But don't let the simplicity fool you. A three fund portfolio has outperformed most comparable actively managed portfolios over the past several decades. In this article, we'll look at what comprises a three fund portfolio, its diversification, its historical returns, and how to easily build and manage the investments. We'll also look at a few ways you can supercharge the returns without a significant increase to volatility by adding a few more funds to the mix.

What is a 3-Fund Portfolio?

A three fund portfolio, as the name suggests, consists of just three mutual funds. The three funds cover U.S. stocks, international stocks and U.S. bonds.

U.S. Stocks

The U.S. stocks portion of the portfolio typically consists of a total market index fund. These funds invest in virtually all of the available public companies headquartered in the United States. An example of such a fund would be the Vanguard Total Stock Market Index Fund (VTSAX).

In some cases, an investor can choose to substitute an S&P 500 Index Fund in place of a total market stock index fund. The historical returns and volatility of a total U.S. market index fund and S&P 500 Index fund are very similar. While I prefer a total stock market fund in a three fund portfolio, this may not be an option inside of a 401k or other workplace retirement account. In those circumstances, an S&P 500 Index fund is a perfectly sound alternative. 

International Stocks

For the international stocks, there are many total international stock index funds that one could use. I've invested in Vanguard's Total International Stock Index Fund (VTIAX) for years. This fund invests in public companies headquartered outside of the United States, including in both developed countries (e.g., Germany and France)  and emerging markets (e.g., Brazil and China).

U.S. Bonds

For the bond portion of the portfolio, an index fund focused on U.S. bonds is typically used. For example, the Vanguard Total Bond Market Fund (VBTLX) would make an ideal investment for the three fund portfolio. This fund seeks to track the investment performance of the Bloomberg Barclays US Aggregate Float-Adjusted Index.  This index broadly tracks the government and investment-grade U.S. bond market.

Is a 3-Fund Portfolio Diversified?

At first glance, the three fund portfolio may not seem well-diversified. With just three funds, one can mistakenly believe that it's too narrowly focused. Here it's important to remember that one cannot determine the diversification of a portfolio based on the number of mutual funds or ETFs in the portfolio. I've seen investment advisors put clients in more than 20 funds, and yet have very little diversity.

In the case of the three fund portfolio, it is extremely diversified. For equities, it includes companies headquartered in both the United States and throughout the world. It includes both large companies and small companies. And while the bond portfolio invests just in U.S. bonds, it covers both government and corporate bonds. 

In fact, each of these funds represent investments in thousands of  stocks and bonds:

  • Vanguard Total Bond Market Index Fund:  10,025 bonds
  • Vanguard Total Stock Market Index Fund:  3,640 stocks
  • Vanguard Total International Stock Index Fund:  7,361 stocks

 Yeah, a three fund portfolio is diversified.

Historical Returns of a 3-Fund Portfolio

The returns of the portfolio depend in large part on how much of the portfolio is allocated to each of the three funds. We'll look at that in a minute. Based on a standard 80/20 portfolio, however, the returns have been excellent over the last several decades. In fact, over the long-term this portfolio outperforms the majority of actively managed mutual funds.

Since 1987, the three fund portfolio has returned compound annual growth rate of over 16% using the following allocation and assuming a $10,000 starting balance and $500 monthly contributions adjusted for inflation:

  • US stock market 50%
  • Global stock market excluding the U.S. 30%
  • Total U.S. bond market 20%
3 Fund Portfolio Performance

Here, it's important to understand how contributions to a portfolio can affect its returns. In the above screenshot, I assumed a starting balance of $10,000 in January 1987. I also assumed monthly contributions of $500, adjusted for inflation. If instead we assumed a $10,000 initial contribution with no additional monthly investments, the compound annual growth rate of the portfolio would be just over 8.5%. 

Why would this be? It's because the monthly contributions were made at different price points. With dollar-cost averaging, we invest in both good times and bad. This stream of investments affect the compound annual growth rate of a portfolio, just as systematic withdrawals in retirement do.

Regardless, the three fund portfolio has performed very well over the last three to four decades.

How to Create a 3-Fund Portfolio 

We need to answer three questions when building a three fund portfolio:

  1. What percentage do we allocate to each fund?
  2. What mutual fund family do we use?
  3. Where do we hold our investments?

What percentage do we allocate to each fund?

For long-term investors saving for retirement, I believe that a 90/10 portfolio is ideal. Such a portfolio, however, will from time to time suffer significant losses in the short-term. For those that are unwilling to handle that volatility, an 80/20 or even 70/30 portfolio is certainly reasonable.

As you make the decision, keep in mind that the expected returns and volatility can vary significantly based on the stock to bond allocation. Indeed, it's the most important decision one makes with regard to asset allocation. The following chart shows the compound annual growth rate and standard deviation of these three portfolios based on an initial contribution of $10,000 and no additional monthly Investments. 

3 Fund Portfolio Asset Allocation
Allocation options for 3-fund portfolio

The above allocations are merely suggestions. One of the features of the three fund portfolio is that you can customize the allocation to your specific requirements. Even within say a 90/10 portfolio, there's no set rule on how much should be allocated to U.S. stocks vs international stocks, for example.

That being said, I tend to put about 60% of the stock allocation in U.S. stocks and 40% in international stocks. This is consistent with the Bogleheads' approach. 

What mutual fund family do we use?

You can build a three fund portfolio using any low-cost index funds. While Vanguard is the most popular choice, it's certainly not the only option. Below I've listed mutual fund options from major mutual fund companies, and I've also included the ETF options from Vanguard.  I've also included the funds one could use from the Thrift Savings Plan to build a three fund portfolio.

Vanguard

  • Vanguard Total Stock Market Index Fund (VTSAX)
  • Vanguard Total International Stock Index Fund (VTIAX)
  • Vanguard Total Bond Market Fund (VBTLX)
  • Vanguard Total Stock ETF (VTI)
  • Vanguard Total International Stock ETF (VXUS)
  • Vanguard Total Bond Market ETF (BND)

Fidelity

  • Fidelity ZERO Total Market Index Fund (FZROX) or Fidelity Total Market Index Fund (FSKAX)
  • Fidelity ZERO International Index Fund (FZILX) or Fidelity Total International Index Fund (FTIHX)
  • Fidelity U.S. Bond Index Fund (FXNAX)

Charles Schwab

  • Schwab Total Stock Market Index (SWTSX)
  • Schwab International Index (SWISX)
  • Schwab U.S. Aggregate Bond Index Fund (SWAGX)

Thrift Savings Plan

  • C fund
  • I Fund
  • F Fund, or alternately, the G Fund

T. Rowe Price

  • Total Equity Market Index Fund (POMIX)
  • International Equity Index Fund (PIEQX)
  • U.S. Bond Enhanced Index Fund (PBDIX) 

How to Build a 3-Fund Portfolio in M1 Finance

One of the easiest ways to build and manage the three fund portfolio is through M1 Finance. M1 Finance is an online broker that charges virtually no fees and makes building and rebalancing a portfolio very easy.

One key aspect that makes it ideal is that the portfolio can be rebalanced with the click of a button. M1 Finance does not charge any trading fees, and you can set the allocation of each fund as you wish. As you make new contributions, M1 Finance allocates them to the funds in your portfolio in a way to rebalance them to your original asset allocation.

I created the portfolio in M1 Finance, which you add to your portfolio in M1 Finance if you use the broker.

Supercharge the 3-Fund Portfolio

There are several ways one can increase the expected returns of a three fund portfolio without significantly increasing its volatility. While these require investing in additional funds in the portfolio, the portfolio is still very manageable. In addition, if you use M1 Finance, the addition of one, two or three more funds does not increase the work required to manage the portfolio.

4-Fund Portfolio–U.S. Small Cap Value

A 4-fund portfolio adds a small cap fund to your portfolio. It's common to use a fund focused on value stocks given their long-term performance.  If you choose to add a small cap fund, you can replace the Vanguard Total Stock Market ETF with a Vanguard S&P 500 ETF, although this certainly isn't necessary.

4 Fund Portfolio
4-fund portfolio

5-Fund Portfolio–Emerging Markets

A 5-fund portfolio adds emerging markets to the international portion of the portfolio.  Emerging markets have a higher expected return than developed countries, but they also have significantly more volatility. In the context of an overall portfolio, however, the added volatility should be minimal.

5 Fund Portfolio
5-fund portfolio

6-Fund Portfolio–REIT

A 6-fund portfolio adds real estate.  Here it's important to make sure that any REIT funds are held in a tax-deferred retirement account. REITs distribute a significant percentage of their income each year that is taxed as ordinary income. As a result, I would not recommend this 6-fund portfolio for a taxable account.

6 Fund Portfolio
6-fund portfolio

FAQs

What is a three fund portfolio?

Three fund portfolio is one designed using just three mutual funds or ETFs. Typically, the funds used are a total stock market index fund, a total international stock index fund and a total U.S. Bond Fund.

How much should be allocated to each bond in a three fund portfolio?

There is no hard and set rule. The Bogleheads version of the three fund portfolio is typically an 80/20 portfolio, with 50% allocated to US stocks, 30% allocated international stocks and 20% allocated to U.S. bonds.

Do I have to open up a Vanguard account to invest in Vanguard funds?

No. You can invest in Vanguard mutual funds and ETFs from just about every broker. 

How do you create a three fund portfolio?

You create a three fund portfolio by investing in a U.S. stock index fund, and international stock index fund and a U.S. bond index fund. 

Final Thoughts

The 3-fund portfolio is an easy, diversified and low-cost way to invest. In my view, it should constitute the core of any portfolio, if not the entire portfolio. M1 Finance is an ideal broker to build the 3-fund portfolio, given its zero trading costs, ability to invest small amounts of money, and easy rebalancing tools.

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