When you’re investing for retirement, there are plenty of ways to get started. One popular option is to choose a target date fund, which you might find in your employer’s 401(k) or a self-directed IRA. But did you know there’s another simple, yet powerful investment strategy you can explore? Enter the three-fund portfolio—a streamlined approach that allows you to diversify your investments and manage your risk with just three core funds. Let us dive into how it works.
What’s a Three-Fund Portfolio?
At its core, a three-fund portfolio is a strategy where you divide your investments between three types of funds: one that covers U.S. stocks, one for international stocks, and one for bonds. These funds are typically mutual funds or exchange-traded funds (ETFs) that offer exposure to a wide variety of securities, making them an easy way to diversify without having to pick individual stocks or bonds.
The beauty of this setup is simplicity. Instead of managing dozens of individual stocks, you have a well-rounded, low-maintenance portfolio. A typical three-fund portfolio allocation is 40% U.S. stocks, 30% international stocks, and 30% bonds. This breakdown offers a good balance of growth potential from stocks and stability from bonds.
Over time, as you get closer to retirement (or your financial goals), you can adjust the balance. For example, you might start with a 70/30 mix—70% in stocks (split between U.S. and international) and 30% in bonds—and gradually shift the stock-to-bond ratio to become more conservative as you near your target date.
Why Should You Consider a Three-Fund Portfolio?
A three-fund portfolio isn’t just simple—it’s also cost-effective. Because these funds are more passively managed than other investment options, the fees tend to be lower. Lower fees mean more money stays in your account, which can grow over time thanks to the power of compounding. In the long run, those small savings in fees can make a big difference to your bottom line.
Another advantage is flexibility. Unlike target date funds, which automatically adjust your asset allocation over time, you have more control over how and when you make changes to your three-fund portfolio. You can decide how aggressive or conservative you want to be, and then rebalance the portfolio as needed based on market conditions or your evolving goals.
If you’re comfortable taking on a bit of extra responsibility, a three-fund portfolio can be a great alternative to more hands-off options like target date funds. You’ll have more control and potentially lower costs, but with that comes the responsibility of making sure your portfolio stays balanced and aligned with your goals.
The Rebalancing Act
One thing to keep in mind is that a three-fund portfolio isn’t a set-it-and-forget-it solution. Over time, you’ll need to rebalance your portfolio to ensure your allocation stays in line with your risk tolerance and timeline. For example, as you get closer to retirement, you might want to reduce your exposure to riskier assets like stocks and increase your bond allocation for more stability.
Rebalancing might sound complicated, but it is actually a simple process. It just involves reviewing your portfolio periodically to ensure the percentage in each fund is still aligned with your goals. And if you’re not sure how to go about this, that’s where a CERTIFIED FINANCIAL PLANNER™ can help. Your CFP® professional can help you determine when and how to adjust your portfolio, keeping you on track as you move closer to your retirement goals.
Should You Choose a Three-Fund Portfolio?
If you want a straightforward, cost-effective way to diversify your investments, a three-fund portfolio might be an excellent option for you. It offers a clear structure that’s easy to understand, and it can be tailored to fit your risk tolerance and timeline. Plus, it’s a great choice for anyone who’s looking to take a more hands-on approach to investing without getting overwhelmed by complexity.
A three-fund portfolio can be a great alternative to a target date fund if you want more control over your asset allocation or if you’re looking for a simple and low-cost way to invest for the long term.
If you’re unsure about how a three-fund portfolio fits into your overall financial plan, a CERTIFIED FINANCIAL PLANNER™ can provide personalized advice. They can help you decide if this strategy is right for your needs and guide you through the process of setting up and maintaining your portfolio.