The three-fund index fund portfolio is one of the most celebrated strategies for long-term investors, popularized by the “Bogleheads” community after Vanguard founder Jack Bogle. It combines simplicity, maximum diversification, and extremely low cost, making it an ideal choice for beginners aiming to build wealth without complexity. The portfolio achieves global diversification by holding just three low-cost, broad-market index funds.
Step 1: Understand the Three Core Components
The three-fund portfolio is designed to provide exposure to the entire global stock and domestic bond markets, balancing growth potential with volatility mitigation.
| Component | Description | Investment Goal |
| 1. Domestic Stock Fund | Tracks the entire US (or your home country’s) stock market (e.g., the Total Stock Market Index). | Long-term growth and capital appreciation. |
| 2. International Stock Fund | Tracks the total stock market of developed and emerging countries outside the domestic market. | Global diversification to reduce country-specific risk. |
| 3. Domestic Bond Fund | Tracks the total domestic bond market (e.g., government, corporate, and agency bonds). | Stability, lower volatility, and income generation. |
These funds should be index funds (either traditional mutual funds or Exchange-Traded Funds (ETFs)) with the lowest possible expense ratios (ideally $<0.10\%$).
Step 2: Determine Your Asset Allocation
The most critical decision is determining the percentage weight of each fund, known as asset allocation. This is based primarily on your time horizon and risk tolerance.
- Stocks vs. Bonds: Stocks (Funds 1 & 2) offer higher potential returns but greater volatility. Bonds (Fund 3) offer lower returns but more stability.
- Younger Investors (Long Time Horizon): Can afford to take on more risk. A common split is 80%–90% Stocks (Funds 1 & 2) and 10%–20% Bonds (Fund 3).
- Older Investors (Shorter Time Horizon): Require more stability. A split like 60% Stocks and 40% Bonds is often more appropriate.
A common approach for the stock portion is to allocate approximately 60% to domestic stocks and 40% to international stocks to reflect the global market capitalization.
Example for a Young Investor:
- $80\%$ Total Stock Allocation (Split $60/40$):
- Domestic Stocks: $80\% \times 60\% = 48\%$
- International Stocks: $80\% \times 40\% = 32\%$
- Bonds: $20\%$
Step 3: Select Your Funds and Account
- Open an Account: Choose a low-cost brokerage (like Vanguard, Fidelity, or Schwab) and open a tax-advantaged account, such as a 401(k) or IRA, or a regular taxable brokerage account.
- Select Funds: Choose one low-cost total market index fund or ETF from your broker for each of the three categories. Most major brokers offer equivalent funds with near-zero or extremely low expense ratios.
- Example (Vanguard): VTSAX (Domestic Stock), VTIAX (International Stock), VBTLX (Domestic Bond).
Step 4: Fund and Rebalance
- Fund the Account: Deposit your initial investment and set up automatic, regular contributions.
- Purchase Funds: Allocate your money according to the percentages you decided in Step 2.
- Rebalance: Over time, market movements will shift your allocations (e.g., if US stocks soar, their percentage in your portfolio will exceed the target). To maintain your risk level, you must periodically rebalance (usually annually) by selling high-performing assets and buying low-performing ones until your portfolio returns to the target allocation.
The three-fund portfolio is a powerful strategy because it relies on simplicity and compounding over decades, rather than trying to beat the market.
