Week 19 Day 6: The Three-Fund Portfolio

The three-fund portfolio: VTI (U.S. Total Stock Market) + VXUS (International Stock) + BND (U.S. Total Bond Market). A typical allocation for someone in their 30s: 50% VTI, 30% VXUS, 20% BND. For someone in their 50s: 40% VTI, 20% VXUS, 40% BND. Simple. Cheap. Diversified across thousands of stocks and bonds in dozens of countries.

Why three funds is enough: VTI holds approximately 3,800 U.S. stocks across all sizes (large, mid, small). VXUS holds approximately 8,000 international stocks across 46 countries (developed and emerging). BND holds approximately 10,000 U.S. bonds (Treasury, corporate, mortgage-backed). Combined, you own roughly 11,800 stocks and 10,000 bonds spanning the globe. The weighted average expense ratio is approximately 0.04%. Alternative implementations: at Schwab use SWTSX + SWISX + SCHZ. At Fidelity use FSKAX + FTIHX + FXNAX (or the ZERO versions for the stock funds). At iShares: ITOT + IXUS + AGG. The Vanguard Target Date funds (e.g., VFIFX for target year 2050) hold essentially the same three building blocks and automatically rebalance and become more conservative over time. If you want maximum simplicity, one target date fund is a legitimate one-fund portfolio. The debate on international allocation: U.S. stocks represent about 60% of the global market cap. A global market-weight portfolio would be 60% U.S. / 40% international. Many Boglehead investors use 70% U.S. / 30% international due to home bias preferences and U.S. historical outperformance.

The three-fund portfolio's intellectual lineage traces to the Capital Asset Pricing Model (CAPM, Sharpe 1964, Lintner 1965) and the mutual fund separation theorem (Tobin 1958): all investors should hold the same portfolio of risky assets (the market portfolio), differing only in the allocation between the market portfolio and the risk-free asset. In theory, the market portfolio includes all investable assets -- global stocks, bonds, real estate, commodities, private equity, etc. In practice, VTI + VXUS + BND approximates the liquid, accessible portion of this theoretical portfolio. The international allocation debate has empirical support on both sides. From 2010-2024, a 100% U.S. portfolio dramatically outperformed a global portfolio (U.S. large caps returned approximately 13% versus international developed at approximately 5%). However, from 2000-2009, international stocks significantly outperformed U.S. stocks (MSCI EAFE at approximately 1.2% vs. S&P 500 at approximately -0.9%). Asness, Israelov, and Liew (2011) showed that the U.S. vs. international performance gap is largely explained by changes in relative valuations (the U.S. became progressively more expensive). With U.S. stocks at a CAPE ratio of 35+ versus international at 15-18 as of 2024, the value opportunity may favor international for the next decade. The optimal international allocation under estimation uncertainty (Pastor and Stambaugh, 1999) is approximately 30-40% of equities for a U.S.-based investor.