The Three-Fund Portfolio

As physicians, our time is limited, and trying to figure out where to invest our hard earned money can be overwhelming, especially with the number of options out there and the sales pitches often made to physicians. The three fund portfolio method offers simplicity, a tried and true pathway to wealth, and a way to create diversification in your portfolio without the hassle of investing in individual stocks. Learn more below!

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Introduction to the Three-Fund Portfolio

So many companies and influencers want to sell you the latest and greatest get rich quick scheme. And since we aren't taught anything about financial planning in our formal education, it can be hard to tell who to trust and what opportunities are your best bet for investing. The idea of spending hours researching the stock market can be overwhelming for busy professionals who value their time and money. Many delay investing in their prime years and only start preparing for it near retirement, missing out on the best investing years. Or they outsource their future to financial advisors without understanding what they're invested in or why, which can leave them vulnerable to bad advice.

The three-fund portfolio is a historically proven great investing strategy that has a long track record of success, thanks to its features we're going to cover below.

What is the Three Fund Portfolio?

The reality of successful investing is much more boring than what many influencers and "finance gurus" will pitch you. Target index funds are recommended in financial circles as one of the most simple and effective ways to grow your wealth for retirement, but you don't hear a lot about them on Instagram or TikTok because, let's be honest, they aren't sexy.

The three-fund portfolio takes the target date index fund approach and adds flexibility (and lowers fees!) by focusing on three funds:

• a domestic total stock market fund

• an international total stock market fund

• a bond total market fund

Between these three types of funds, which can consist of mutual funds or ETFs depending on what you choose, you will have broad diversification across the market, without having to keep track of lots of individual stocks and bonds. In general, once you pick the three funds you have, you will have very few decisions to make going forward, and if you do have to make changes, it's easy to adjust your portfolio without looking at hundreds of holdings.

There are some cons, in that you will have less control over what you're investing in, but most people who choose to use the three fund portfolio are okay with that. In theory, if a fund underperforms, it will have a large impact, but these funds are created to hold enough assets that any individual company doing poorly won't bring down the entire fund. If one of these funds is doing poorly, it's generally because the market as a whole is doing poorly in that asset class, so most stocks or bonds you would have picked in that asset class also would have done poorly.

If you do want to add some types of assets that aren't covered by these three categories to increase your diversification, you can always add funds to these three. That's often referred to as the modified three fund portfolio. For example, if you want more exposure to real estate, commodities, or cryptocurrencies, you could add funds in these sectors. Proponents of the three fund portfolio would advocate for keeping the percentage in these add on funds small, like 5-10%, just for some exposure. But the whole point is to keep it simple.

If you aren't familiar with terms such as stocks, bonds, mutual funds, ETFs, commodities, and REITs, you can learn their definitions on this page about common types of investments that we see doctors using.

Where The Three Fund Portfolio Comes From

The three-fund portfolio is credited to the Boglehead following, named for John C. Bogle, the founder of Vanguard. The Boglehead following have two investing books we recommend if you want to learn more not just about the three-fund portfolio, but the basics of investing including retirement accounts, estate planning, and more:

The Bogleheads' Guide to Investing

The Bogleheads' Guide to the Three-Fund Portfolio: How a Simple Portfolio of Three Total Market Index Funds Outperforms Most Investors with Less Risk will teach you the concept of index fund investing and how to diversify your portfolio with minimal fees and historically same or better performance than most financial advisors. This is a LOT easier than it looks. As in, checking in on your investment account a few times a year. Strongly believe this book can save you hundreds of thousands, if not millions, over the course of your career.

Why We Love the Three-Fund Portfolio for Physicians

The three-fund portfolio is lazy investing at its best. It's simple, it's proven to have a better long-term track record of gains than picking single stocks and trying to time the market, and it lets you generally "set it and forget it" when it comes to saving for retirement. By selecting total market funds, you can help keep your tax burden low in non-retirement accounts. And by spreading your investing across three board-spectrum funds, you earn diversification to help spread risk and balance losses in times of market swings.

Many of the top total market funds have upwards of 3,000-4,000 funds, allowing you a high diversity of assets, while you only have to focus on selecting three funds to manage them all.

Selecting Specific Funds to Include for Your Three Fund Portfolio

There are several total market funds available in the marketplace through companies such as Charles Schwab, Fidelity, and Vanguard. When selecting your three funds, one of the biggest factors to consider is the expense ratio. Expenses within funds can be depictive, as you never see the expenses charged as fees to your account. The expenses are taken from the funds before returns and dividends. Without looking up the expense ratios of funds, you might not understand their true cost because you don't physically see the impact of higher expense ratios in your retirement or brokerage accounts.

In general you're going to want low fee funds with great diversification that roughly mirror the market as a whole.

Remember, we are not financial professionals, so this is not individualized advice. You should do your own due diligence before picking the funds. Some specifically follow the major US stock indices, like the S&P 500. Some popular ones on our physician communities are:

Domestic total stock market index fund: VTSAX (Vanguard Total Stock Market Index Admiral Shares), VTI (Vanguard Total Stock Market Index Fund ETF), VOO (Vanguard S&P 500 ETF)

International total stock market index fund: VXUS (Vanguard Total International Stock ETF), VT (Vanguard Total World Stock ETF), VTIAX (Vanguard Total International Stock Index Fund Admiral Shares)

Total bond market index fund: BND (Vanguard Total Bond Market Index Fund ETF)

We've mentioned the Vanguard versions because these are the ones you tend to hear about most on the communities and are often available outside of Vanguard as well, but Fidelity, Charles Schwab, and other popular brokerages have their own versions of these. They are easy to look up, but for example there is FXAIX (Fidelity 500 Index Fund).

In the section below, you'll notice we make the distinction of index funds, as they will have a lower expense ratio than similar managed funds.

Learn more about index funds and other commonly used types of investments for physicians.

Asset Allocation: Percentages by Type of Fund in the Three Fund Portfolio

The biggest question when it comes to the three-fund portfolio is how to balance the three type asset classes of:

• a domestic total stock market index fund

• an international total stock market index fund

• a bond total market index fund
  

This is where the flexibility in our graphic above comes into play. You can set your allocation by fund based on your age and risk tolerance. Bonds are typically considered more conservative that the domestic and international funds, so they are sometimes weighted more heavily for older investors or investors with lower tolerance of market fluctuations.

Most early to mid career physicians in our communities choose to take a more aggressive approach, with 80+ percentage in the total domestic and international stock market index funds, for the largest amount of growth in their net worth earlier in their careers. This is because the more growth you have early, the more that will compound over decades for a quicker pathway towards financial independence. Because a portfolio has many decades to recover before retirement in your thirties and forties, dips in the market are not as concerning for physicians who are in their earning years and don't have to dip into their savings at a time where they'd have to take a loss. As you progress to later stages in your career and approach retirement, you'll want to increase the allocation of bonds, also referred to as fixed income.

Here are three of the popular allocations across the three different asset types:

Setting and Forgetting: A Caution

While the three-fund portfolio is great because it's simple to learn and easy to manage, it isn't without its disadvantages, as we discuss on our personal finance for physicians primer. While the three-fund portfolio has a "set it and forget it" mentality when it comes to selecting funds and asset allocation, keep an eye on your overall portfolio long-term to ensure the balances remain near the target percentages as they grow. If one of the three arms ends up doing significantly better, you may want to consider either rebalancing your portfolio to adjust for the gains or change the percentages of future investments to even out your diversification.

One of the features we highlight of the three-fund portfolio above is that it allows for flexibility when selecting your balance between the three-funds. Another caution against the "set and forget" mentality over the entirety of your life is that your risk tolerance over passing decades may change as you get closer to retirement. This is where the flexibility also comes in hand, allowing you to adjust the stock-to-bond ratio when you want to shift your portfolio to be more conservative in your golden years.

As your net worth grows and you look to diversify even more, you may want to consider something a little more advanced, like the four-fund portfolio, that includes other asset types such as REITs.

Learn more about REITs on our common types of investments page.

Additional Investing Resources for Physicians

If you're ready to explore more investment options, check out our physician's guide to getting started with investing for lots of resources or explore other popular options for "lazy" investing. You can also check out our personal finance for doctors primer for more information on retirement and tax-advantaged saving.

Explore our database of financial advisors for physicians to find a fee-only, fiduciary financial advisor if you love the idea of DIY but don't trust yourself to keep calm and invest on during market dips. These advisors can help you rebalance and realign your investments throughout your wealthbuilding journey.

Empower is free way to aggregate your accounts and get a comprehensive overview of your finances. It includes lots of retirement tools/trackers/long-term financial tools that address questions often asked on the group in terms of tracking net worth, a savings tracker that shows you if you’re on track towards retirement goals, budgeting, cash flow, and fancier things like a retirement planner that will calculate your projected monthly income by your desired retirement date, planning for your kids’ education costs, portfolio allocations, and even analyzing the fees in your investments to make sure you’re aware of hidden fees. Empower Personal Wealth, LLC (“EPW”) compensates us for new leads. We are not an investment client of Empower Advisory Group, LLC.