Investing

How To Build A Low Cost Portfolio

How To Build A Low Cost Portfolio

In this article, I will discuss what a KISS (Keep It Simple, Stupid) portfolio does. That is, it aims to keep portfolio construction simple. Now within this framework, one can keep it really simple with a 2 fund portfolio or add just a little more complexity by adding an international stock and a Real Estate Investment Trust (REIT) portfolio to give it some international exposure and dividend yield and growth.

2 Fund Low Expense Portfolio 

2 Fund Concept

The idea of a Two (2) Fund portfolio is simple. By buying just two broad market index funds, an investor can access to some of the largest global equity and bond issues. An investor would have a very diversified portfolio with this simple portfolio.

What the 2 Funds Do

In a 2 Fund Portfolio, one fund would be a broad based global equities (stock) portfolio that holds 5000-10000 equities in just one fund. The other fund would hold fixed income (bond) issues of the largest US only or global companies.

Generally speaking, investors can think of equities are the investments that offer growth (and some income in the form of dividends). However, equities are more volatile. Bonds are generally more stable than equities; whereas investors buy equities for growth, people buy bonds for the interest payments and expect to get the full amount of the principal (original amount) back. Bonds benefit

2 Fund Portfolio Advantages

The most obvious advantage is its simplicity. As noted above, the 2 Fund Portfolio is very simple. Just pick one equity index fund and one bond index fund and you’re done. You might be rebalance once a year, but other than that, you buy in and leave it alone. It doesn’t get simpler than that. 

2 Fund Portfolio Disadvantages

The biggest disadvantage is that investors may miss out on opportunities that arise from difference economic conditions (say, inflationary periods), high growth geographies (emerging markets), or additional sectors (real estate).

2 Fund Sample Portfolio

For a 2 Fund portfolio, the Vanguard Total World Index Fund (VTWSX) is frequently cited as the preferred equity fund. The Vanguard Total World Index Fund holds close to 7,000 global equities and has an expense ratio of 0.27% ($27 for every $10,000 invested per year). The Vanguard Total Bond Market Index Fund (VBMFX) invests 30% of holdings in US investment grade corporate bonds and the remaining 70% in US government bonds. The expense fee is 0.20% ($20 for every $10,000 invested per year).

2 Fund Ideal Mix

For most people under age 55, a good mix would be 60% in the Vanguard Total World Index Fund (VTWSX) and 40% in The Vanguard Total Bond Market Index Fund. As one gets near or during retirement, it makes sense to shift more of the mix to the bond fund for preservation of capital.

Watch John Bogle, the Founder of the Vanguard Group, the largest mutual fund company in the world, discuss the merits of index investing.

 

3 Fund Low Expense Portfolio

3 Fund Concept

The concept of a 3 Fund Portfolio is similar but instead of 2 funds, you add one more for diversification and exposure to countries that may have higher growth rates than developed countries. In addition to the funds used in a 2 Fund portfolio, an investor adds an international equities fund to the mix.

3 Fund Portfolio

In addition to the (1) Vanguard Total World Index Fund (VTWSX) and (2) Vanguard Total Bond Market Index Fund, an investor adds the (3) Vanguard Total International Stock Index Fund (VGTSX).

3 Fund Portfolio – Advantages

The biggest advantage of a 3 Fund Portfolio is the increased diversification and exposure to international equities and economies. This portfolio would have a small percentage in US based equities.

3 Fund Portfolio – Disadvantages

The 3 Fund portfolio is more diversified but may still lack exposure to emerging markets and more sector specific investments, but it’s a nice improvement from a 2 Fund portfolio.

3 Fund Sample Portfolio

A 3 Fund portfolio would include (1) the Vanguard Total World Index Fund (VTWSX); (2) the Vanguard Total Bond Market Index Fund (VBMFX); and (3) the Vanguard Total International Stock Index Fund (VGTSX). This international fund holds close to 6,000 equities with a 0.22% expense ratio ($22 for every $10,000 invested per year).

Related: Learn about how to lower your investing costs.

3 Fund Ideal Mix

For most people under age 55, a good mix would be 34% in the Vanguard Total World Index Fund (VTWSX); 34% in the Vanguard Total International Stock Index Fund (VGTSX); and 33% in the Vanguard Total Bond Market Index Fund. As one gets near or during retirement, it makes sense to shift more of the mix to the bond fund for preservation of capital.

Related:  See why it’s important to pay yourself first.

4 Fund Low Expense Portfolio

4 Fund Concept

The 4 Fund Portfolio is basically a 3 Fund Portfolio with a Real Estate Investment Trust (REIT) fund added to it. By adding a REIT portfolio, you add some diversification, growth, and higher yield.

4 Fund Portfolio

In addition to the (1) Vanguard Total World Index Fund (VTWSX) and (2) Vanguard Total Bond Market Index Fund, and (3) Vanguard Total International Stock Index Fund (VGTSX), an investor adds the Vanguard REIT Index Fund (VGSIX).

4 Fund Portfolio – Advantages

The advantage of a 4 Fund Portfolio is the increased further diversification, dividend yield, and higher growth exposure. The presence of real estate adds an element of inflation hedge as well.

 4 Fund Portfolio – Disadvantages

The 4 Fund portfolio is more diversified but usually the suggested exposure to the REIT fund is only 6-10%, so it’s a relatively small mix.

 4 Fund Sample Portfolio

A 4 Fund portfolio would include (1) the Vanguard Total World Index Fund (VTWSX); (2) the Vanguard Total Bond Market Index Fund (VBMFX); (3) the Vanguard Total International Stock Index Fund (VGTSX); and (4) the Vanguard REIT Index Fund.

4 Fund Ideal Mix

For most people under age 55, a good mix would be 36% in the Vanguard Total World Index Fund (VTWSX); 18% in the Vanguard Total International Stock Index Fund (VGTSX); 20% in the Vanguard Total Bond Market Index Fund; and 8% in the Vanguard REIT Index Fund. As one gets near or during retirement, it makes sense to shift more of the mix to the bond fund for preservation of capital.

Additional Resources:

Lazy Portfolios by Bogleheads

Two Fund Portfolio by Kiplinger

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1 Comment

  1. May 5, 2015 at 10:11 am — Reply

    These i-bankers have been understating the whole cridet crisis issue since last summer.The higher mortgage bond weighting in Bill Gross’ portfolio is likely a reflection of the extreme mispricing in those assets rather than an indication of the end of the financial storm. In fact, the housing market is still in the midst of a huge wave of foreclosure which will for sure depress housing prices even further. This will of course adversely affect the US economy substantially. In the next few months we will see the real impact of financial markets’ bad news on main street America.

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