Planning for Retirement? Simplify, Simplify … to Just 3 Funds

by Marc Bastow | August 9, 2013 1:57 pm

There’s no single bulletproof plan in constructing a retirement portfolio. You have to consider things like time horizons and asset allocations among risk-on and risk-off markets — to say nothing of choosing investments from an endless selection of stocks and funds.

retirementinsights[1]Well, The Wall Street Journal’s Anna Prior refreshingly suggests that “less is actually more[2],” highlighting a trend that’s getting some traction — a simplified look at investing that involves very few mutual funds or ETFs.

Like, three.

Of course, while that might simplify your brokerage account, it doesn’t simplify the decision as to which funds to buy. Because it depends.

Before you attempt to narrow down your portfolio to just three investments, at least ask and answer these two questions: 1) What is your time horizon, and 2) What is your risk tolerance?

While yours might be different than mine, I’d like to use my own personal situation to show you an example of how you can find a comfortable investment trio:

Time Horizon: 10 to 15 years
Risk Tolerance: Moderate to high

Just for benchmark’s sake, Prior turns to a textbook trio consisting of

  1. a U.S. stock market proxy, Vanguard Total Stock Market Index (VTSMX[3]), at 40% of the portfolio;
  2. a bond market proxy, Vanguard Total Bond Market Index (VBMFX[4]), at another 40%; and
  3. an international market proxy, Vanguard Total International Stock Index (VGTSX[5]) at 20%.

There’s plenty to like — geographical diversification and a bond fund to help reduce a little risk. But it’s not how I would roll on this one.

I like the notion of a U.S. stock market proxy, and VTSMX isn’t bad by any measure. It has a five-year annualized return of 8.8% and costs just 0.17% in expenses, or $17 of every $10,000 invested.

However, my choice for this category is the SPDR S&P 500 ETF (SPY[6]). The SPY holds many similar names — like Apple (AAPL[7]), Exxon Mobil (XOM[8]) and Johnson & Johnson (JNJ[9]) — but without going overboard on the broad exposure (500 stocks vs. VTSMX’s 3,000). It also yields a bit more in dividends currently, at 1.98% vs. 1.8% for VTSMX, and it charges less in expenses at 0.09%. The only downside is its annualized return is roughly 50 basis points worse over the past five years, but “past performance is not an indicator…” and all that.

As for allocation percentage, it again depends on time horizon. You’re fine with 40%, though if you’re as bullish on U.S. stocks in general as I am, even up to 60% would be appropriate.

As for bonds …. well, in the past, I’ve expressed an aversion to bond funds[10], so you know where I stand. Nonetheless, with the right amount of exposure, bonds can work for you. Before you dive in, though, check out the effective duration in the portfolio; shorter is better for risk purposes, though you might be trading away a bit more in return.

With duration in mind, Prior’s Vanguard Total Bond pick is a nice one. VBMFX has an effective duration of just more than five years, and a cheap 0.2% expense ratio. The fund’s 5.1% annual return for the past half-decade isn’t buying you any yachts, but you won’t lose sleep on the downside, either.

An alternative that gets you just a little bit further out on the duration but with little excess risk: iShares 7-10 Year Treasury Bond ETF (IEF[11]). IEF is invested almost entirely (99%) in U.S.-backed bonds, with an effective duration of just more than seven years. It has returned 5.85% in the past five years, and charges just 0.15% in expenses, plus its 30-day SEC yield sits around 30 basis points higher, at 2.16%.

Regardless of time horizon, I’d allocate 30% here. This is classic protection, nothing more.

Assuming 60% for broad U.S. coverage, and 30% for bonds, we’ve got 10% left to allocate. I’m not a big fan of international exposure simply because — in all honesty — I don’t really feel comfortable assessing country risk, and to this point in time economic “recovery” in Europe feels a long time coming.

But since I can’t make a case to add any additional exposure to U.S. markets, I like the Vanguard MSCI Europe ETF (VGK[12]). The fund is invested in the biggest of the big in Europe, including Nestle (NSRGY[13]), Shell (RDS.A[14]) and HSBC (HSBC[15]), with the average market cap in the ETF at $41 billion. Stock exposure is broken down into 34% in the U.K. and 65% “developed” Europe, with the remainder in the U.S. and Latin America.

Here’s where it gets a bit dicey: VGK’s five-year return is a paltry 1.64%. But take heart: It’s trending upward over its more recent periods — 8.72% over the last 3 years, a very healthy 25% over the past year, and a solid 11% year to date. Another nice feature: fees run a slim 0.12%.

Compared to the model’s VGTSX, it’s all good — expenses are 0.22%, with returns coming in at 1.46% over five years, 5.85% over three years, and 16.71% in the past year.

Heck, maybe I’m wrong about international exposure — this one looks pretty good.

So there we have it: a three-fund portfolio for retirement. What do you think? Have at it and let’s have your thoughts.

Marc Bastow is an Assistant Editor at As of this writing, he was long AAPL, XOM, JNJ and MSFT.

Like what you see? Sign up for InvestorPlace Retirement Insights[16] e-letter and get practical investing advice delivered to your inbox Saturday morning!

  1. [Image]:
  2. less is actually more:
  3. VTSMX:
  4. VBMFX:
  5. VGTSX:
  6. SPY:
  7. AAPL:
  8. XOM:
  9. JNJ:
  10. an aversion to bond funds:
  11. IEF:
  12. VGK:
  13. NSRGY:
  14. RDS.A:
  15. HSBC:
  16. InvestorPlace Retirement Insights:

Source URL:
Short URL: