What to put in the i401k?
OK, let’s go shopping! — The Three-Fund Portfolio
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 and make money—links at the bottom of the page to read more about it.
Let’s look at the investments and the mix of the three to put inside the i401k. Remember, the i401k is the tax-protected vehicle or wrapper that the investments live inside. You can also use a Three-Fund Portfolio in other investment accounts, like a Roth IRA, a 529 for your kid’s education, or a taxable brokerage account.
If you are not already, you’re about to become an investor!
These investments will drive your i401k’s 7%-8% growth over time.
Why use these Schwab ETFs (Exchange-Traded Funds) or Vanguard Mutual Funds?
These simple, safe, low-cost investments drive wealth and retirement savings. By safe, I mean they can’t go broke, unlike buying an individual company’s shares.
We are buying thousands of companies or bonds inside each ETF or mutual fund. If one company goes bad, we will hardly notice.
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.
Our funds match the stock market’s performance. That takes the stress out of trying to figure out which companies will be winners or losers.
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.
Note: As of April 16th, 2024, Vanguard announced that it will no longer manage i401k plans. It has transferred the plans to Ascensus, who will manage them.
The Vanguard mutual funds themselves have not changed (they’re still amazing); they will no longer manage the i401k. Read The Knowledge post on why here.
We have two options:
A single fund inside the i401k that combines the three funds for you.
Use three funds inside the i401k where you control the mix.
What do the Three Funds invest in?
The Total U.S. Stock Market
International Stocks
U.S. Bonds
Why these three sectors?
Diversification:
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.
Low Cost:
The three-fund portfolio uses low-cost index exchange-traded funds (ETFs) or mutual funds. This minimizes investment costs and maximizes how much we make.
Simplicity:
Managing a three-fund portfolio is straightforward. Work your day job and have fun with your friends and family, not wasting time trying to beat the market by picking individual companies.
Stocks vs Bonds — The odd couple.
STOCKS - Long-term average return is 10%, but volatile.
The U.S. and international stock markets will have a return on average of around 10%. Great right? It’s way above the 7% total return I mentioned for the Three-Fund Portfolio. The downside is the volatility; the US stock market, for example, can go up 26% in a year as it did in 2023 or down 50% as it did in 2008-09. During dips, it’s stomach churning. Long-term, it’s a fabulous return.
BONDS - Long-term average return of around 4.3%, but super-steady.
Bonds, on the other hand, have a much lower return of around 4.3% (Using Vanguard BND) but don’t bounce around nearly as much. They are also low volatility.
Why are they combined in a Three-Fund Portfolio?
We mix them together based on how close we are to retirement. When we're younger, we foot 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.
How often do you deposit money and buy?
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 Wall Street crowd as Q1, Q2, Q3, Q4).
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!
The Single-Fund Option
If you choose this option, I suggest you open an account with E*Trade or Acsensus (who took over managing the Vanguard i401k accounts). The single option is just one mutual fund you buy with the three funds inside it. The Vanguard mutual funds do 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. 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.
Well-known advice-only financial advisor Mike Piper does this for his own retirement, and he’s a pro. He buys VASGX - LifeStrategy Growth Fund (80% stocks, 20% bonds)
When you get close to retirement, around five to seven years 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.
If that’s all you need, head to the next section: Opening the i401k. To go more hands-on and have some fun, read on for the Three-Fund version.
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, I’d open an i401k with Schwab.
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: Already have accounts with Fidelity, E*Trade, or another broker? You can open an i401k with them.
You can also use Vanguard ETFs for your Three-Fund Portfolio. The ETF performance is similar to Schwab, and buying them is free.
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: 70%
International: 20%
Bond: 10%
This mix will have the highest return (make the most money) 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.
Rebalancing
You 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!
The three-fund portfolio is a long-tested and revered investing strategy; it’s not my invention. It’s easy, works, and you never have to worry about it. If only the rest of life was this easy!
Here are some links if you want 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