What to put in the i401k?
OK, let’s go shopping! — The Three-Fund Portfolio
U.S. Stocks — International Stocks — U.S. Bonds
The Three-Fund portfolio is a well-known investment strategy that has been around for decades.
It works; it’s simple, but you probably haven’t heard of it because none of the smart-asses on Wall Street want you to know how easy it is to invest long-term and make money.
You don’t need to spend any time watching your investments or researching individual stocks to pick winners. This is not a time suck, it’s super easy.
We invest in three separate areas:
U.S. Stocks
International Stocks
U.S. Bonds
Why do we use a single Index Mutual Fund or the three ETFs?
They are imple, safe, low-cost investments that drive our wealth and retirement savings. By safe, I mean they can’t go broke, unlike buying an individual company’s shares.
What’s an Index Mutual Fund?
A fund contains hundreds or thousands of companies. Investors pool their money to buy assets together, benefiting from shared costs and professional expertise. They are traded at the end of the day and may have a minimum starting amount you need to invest.
What’s an Index ETF?
It’s similar to a mutual fund, except it is traded on the stock market like a regular share. They have no minimum amount you need to invest.
What’s the Index part?
An index is a list of companies created by a financial organization on a stock market exchange. The S&P 500, for example, is the top 500 U.S. companies. It’s a list, so the fees are very low; we’re not paying someone to pick out the companies; that’s called an active fund. 92% of active funds don’t beat the index anyway!
Our funds match the stock market’s performance. That takes the stress and risk out of trying to figure out which companies will be winners or losers.
Why the three different sectors?
Our eggs are in different baskets. The portfolio is diversified by including different asset classes and regions, which can help reduce risk. If the U.S. is having a bad year, hopefully, International and Bonds are not.
Why don’t we buy individual stocks/companies?
Buying individual companies is risky; remember WeWork? They were the hottest thing and ended up filing for bankruptcy in 2023. Google ‘Worldcom’ and ‘Enron’ to see examples of huge companies that imploded. Investors lost nearly everything.
Want to know more?
You can read about the stock market here in The Knowledge. It’s less scary and more simple than you think. The market goes up 2/3 of the time and down 1/3 of the time. Ignore the noise.
Stocks vs Bonds — The odd couple.
This is a bit wonky, but hang in there.
STOCKS
The long-term average return is 10%, but it’s volatile.
The U.S. and international stock markets usually return an average of around 10%. In the last decade, the U.S. has outperformed the International stock market by a long shot. However, from 2000 to 2009, the International stock market was the winner. That’s why we buy both: to diversify as we don’t know what the future will bring.
The downside is volatility. The US stock market, for example, can go up 24% in a year, as it did in 2024, or down 50%, as it did in 2008-09. During dips, this can be stomach-churning. However, in the long term, it’s a fabulous return.
The winner for each year is on the top row. S&P 500 is the U.S. market — MSCI EAFE is International. You can see 2000-2009 was dominated by international stocks.
BONDS
With a long-term average return of around 4.3%, bonds offer a stable and less volatile investment option than stocks.
Companies or governments can issue bonds that have a yield (similar to an interest rate) paid as a dividend. It’s a way for them to raise money. When we buy bonds, we are lending our money to them. Compared to stocks, bonds have a much lower return of around 4.3% (Using Vanguard BND) but don’t bounce around nearly as much. They are less volatile.
Why are they combined in a Three-Fund Portfolio?
We mix them based on how close we are to retirement and how much we can handle the volatility (the rollercoaster).
When we're younger, go foot on the gas with stocks, going for the maximum return. Closer to retirement, we start tapping the brakes, switching to more bonds as we need to spend the money soon. If the market crashes, a retiree can’t wait five years for it to recover.
Make sure you look at The Knowledge Post on the stock market. It’s important to understand its long-term nature and ignore all the noise.
We have two easy options when investing:
A single mutual fund inside the i401k that combines the three funds for you.
Three ETFs inside the i401k where you control the mix.
The Single-Fund Option
If you choose this option, I suggest you open an account with E*Trade
The single option is just one Vanguard mutual fund that does the mix for you. Buy it every quarter, no matter what the stock market does, even if it’s crashing.
There are two types of single-fund:
Target Retirement funds — They are designed to change their mix as you near retirement. As you get older, more bonds, fewer stocks, but you can’t control the mix.
Example: If you’re 30 now and plan on retiring at 65 in 35 years, pick the target date that ends near the year you will retire; that would be Target Retirement 2060, as it's 2023 now.Single fixed allocation funds — Vanguard calls them ‘Life Strategy funds’; they provide a mix of US and International stocks plus bonds that don’t change.
This would be a solid choice:
VASGX - LifeStrategy Growth Fund (80% stocks, 20% bonds)
Three Funds Is All You Need in The Market
Three Funds Is All You Need in The Market
The classic Three-Fund Portfolio
If you decide on the classic Three-Fund, an i401k with Schwab is a good choice, that’s where mine is.
Many sophisticated investors use the Three-Fund Portfolio; in fact, there is a whole community here at Bogleheads (Jack Bogle was the founder of Vanguard). This is not my invention or strategy. It is well respected and has been used for decades.
You may not have heard of it because you’re not an investment geek like me. Also, some parts of the investment industry want you to think you need them and their expensive advice and fees to make money in the stock market. You don’t. There is no money in simplicity, so they don’t advertise the simplicity of investing like this.
What is the advantage of the Three-Fund Portfolio over the Single option?
With the Three-Fund Portfolio, you're in the driver's seat. You get to control the mix (see below), deciding which parts to sell when it comes time to start using the money in retirement. This level of control can also provide a sense of security and confidence in your financial future portfolio. Plus, I think it’s more fun.
Buy these three ETFs every quarter, either the Schwab or Vanguard versions.
SCHB -
Schwab U.S. Broad Market
Index ETF containing around 2,500 U.S. companies.
The fee, called the ‘total expense ratio,’ is 0.03% of your balance every year.
No minimum initial investment.
SCHF -
Schwab International Equity
Index ETF with around 1,500 companies like Toyota, Shell, Samsung, and Heineken.
Expense ratio 0.06%
No minimum.
SCHZ -
Schwab Aggregate U.S. Bond ETF
9,883 bonds issued by companies or the US Treasury.
Expense ratio 0.03%
No minimum.
The Vanguard ETFs:
You can also use Vanguard ETFs for your Three-Fund Portfolio. The ETF performance is similar to Schwab, and buying them is free.
Only buy one set, either Schwab or Vanguard, not both.
VTI - Vanguard Total Stock Market
VXUS - Vanguard Total International
BND - Vanguard Total Bond Market
What mix of the three funds do you use in a Three-Fund Portfolio?
These are examples of mixes you could use.
The aggressive, high-growth mix
U.S. Market: 65%
International: 25%
Bond: 10%
This mix will have the highest return but will be the most volatile, going up and down the most.
The stock market can drop and sometimes takes 3-5 years or longer to recover. This is okay if you are not near retirement, as you don’t need to withdraw any money. The ETFs/Funds have time to go back up. Also, it means you can buy more at lower prices.
ME: At 51 years old, I’m doing this. My return has been closer to 9% with this mix.
A moderate volatility/growth mix:
All U.S. Market: 45%
International: 15%
Bond: 40%
This is a moderate version. It’s the classic 60/40 stocks vs. bonds portfolio, which is often suggested. It will go up and down less, but it will have a slightly lower return as you have more money in bonds.
A Three-Fund experimental mix:
All U.S. Market: 70%
International: 18%
Bond: 10%
Individual stocks: 2%
This aggressive mix adds an allocation for buying individual stocks like Apple, Tesla, or whatever company you are passionate about.
Take it easy on individual stocks. Keep them a really small part of your portfolio, at around 2%. Almost no one can outperform an Index ETF, long term.
Dollar-cost averaging. Image: Charles Schwab
Dollar Cost Averaging - Buy every three months.
I recommend investing every three months, that’s every quarter. This means we are ‘dollar cost averaging,’ catching some of the market's ups and downs during the year. If you want to, you can invest monthly, that’s fine. Just keep investing in a set timetable throughout the year. Remember, the money will come from your business bank account, not your personal one.
Jan 1 — April 1 — July 1 — Oct. 1 (also known by the investment crowd as Q1, Q2, Q3, Q4).
Can you buy every month?
Yes, that works as long as it’s a regular, scheduled buy.Why on a set timetable?
It takes our emotions out of the equation. If the market has just crashed 30% (March 2020 during Covid, anyone?), you won’t want to buy. This way, you short-circuit that emotion; keep buying every quarter no matter what!
Rebalancing
You may need to re-balance the three-fund portfolio sometimes. If International has gone way up one year out of its percentage allocation (say you want it to be 30% of the portfolio), you sell some and then use the money to buy US Stocks and Bonds to get the portfolio to the correct mix. This is normal.
Once a year is plenty, perhaps make it the New Year’s resolution that may actually follow! Rebalance in early January.
Why can’t I go 100% and pick all my stocks?
Read the Knowledge post here to understand why this does not work. It’s the dark side and leads to pain and suffering. Messing up picking individual stocks (and you will) means you’ll be stressed and poorer, and your spouse and dog will leave you. Maybe allocate 2% of your portfolio to stock picking if you want to be adventurous. Then it can be fun as you’re not risking your later-life pile of moolah on a wacko meme stock!
When you get close to retirement, around five out, talk to a Certified Financial Planner (CFP).
I prefer ‘advice only’ financial advisors who charge you for their time, not a percentage of your portfolio. This professional comes up with a comprehensive plan for your retirement investing and spending. They are not trying to pick winning stocks or sell you an investment product they profit from.
The links below will take you to read more about the Three-Fund Portfolio. Smarter people than me came up with it.
https://www.bogleheads.org/wiki/Three-fund_portfolio
https://www.forbes.com/advisor/retirement/3-fund-portfolio
https://www.investopedia.com/3-fund-portfolio-401k-5409269