(ThyBlackMan.com) Years ago I worked for BP Oil and Gas. BP had the best 401-K plan I have contributed to, matching seven percent of my salary, IF I contributed my seven percent. Easy decision!
But one thing I found interesting (the British usage) was the huge number of funds we had to select from. It was well over 200 funds we could choose from. Maybe you love choices, but for many people that was overwhelming. I simply selected three funds, plus the mandatory BP stock (which at the time was how BP made its contribution of seven percent)
BP eventually streamlined their number of funds to about 25, which happens to be the typical number of funds majority of 401-K plans offer today. But, do you even need 25 options. Do you have the 
time to review each fund and understand every fund choice, historical performance, fund manager’s experience, etc? And oh by the way work a full time job and raise a family!
By selecting the right three funds you will mathematically beat majority of 401-K investors’ performance. I choice three market index funds {preference today is three Exchange Traded Funds (ETF) market Index funds}
- US/domestic Total Market Index Fund
- Bond Total Market Index Fund
- International Stocks Total Market Index Fund
ADVANTAGES OF THE THREE-FUND INDEX PORTFOLIO
- Simplicity- KISS
- Diversification of funds with over 10,000 worldwide securities included
- Contains every style and capital size company
- Very low cost. The more funds you invest in, the more you pay in fees. Over time, fees have the potential to significantly cut into your earnings and net worth. {Average US 401-K performance in 2015 was four percent. If you select three low fee funds you will impact your performance by less than 0.10%. But those who select funds with outstanding performance last year may pay up to two percent in fees. A major difference if compounded over 30+ years.}
- Manager’s competency is not a critical factor. Managed Funds performance is almost 100% dependent on the competency of the lead manager and his team. Like any other industry, the best performers are recruited away.
- Easy to rebalance. If your goal is to have 60% US stocks in your portfolio and the US/domestic Total Market Index Fund, significantly outperforms your other two funds, it is relatively easy to rebalance your portfolio back to the desired 60% balance.
- Never under-performs the three markets selected (less worry).
- Mathematically- certain to out-perform most investors.
For those who want even more simplicity, get an all-in-one fund like a Retirement Date Target Retirement Fund.
HOW DO YOU DECIDE WHAT PERCENTAGE OF THE THREE FUNDS TO DIVIDED YOUR 100% SAVINGS?
YOUR ALLOCATION IS BASED ON YOUR RISK TOLERANCE
- Your first decision is what percentage of your stock allocation will be U.S. (domestic) and what should be international. This is a much less critical decision because U.S. and international stocks have similar risk profiles and have similar long-term returns
- Second decide what percentage in bonds. Some people use a VERY CONSERVATIVE RULE OF TUMB- your actual age in bonds. So a 32 years old woman would place 32% of her portfolio in a Bond Total Market Index Fund. Personally, I have never been that conservative in my allocations, but this is based on YOUR risk tolerance.
Typically the younger you are, the higher your risk tolerance (you have more years or decades to recover), so you would allocate more to stocks.
EXAMPLE ALLOCATIONS FOR THE THREE-FUND STRATEGY:
- Total Stock Market ETF (VTI) -60%
- Vanguard Total International Stock Index Fund (VXUS- 20%
- Vanguard Total Bond Market ETF (BND).) -20%
CONCLUSION
I believe in the KISS principle when it comes to investments. The above three-fund strategy will hopefully keep you from constantly reacting and panicking WHEN we have the next market correction. My advice remains buy ETF’s (when offered) and heavily allocate to stocks when you are young.
The simplest way to invest is through a target-date fund. Even if you are going to use a single Target Date Retirement fund, you should not take the shortcut implied by the use of a retirement year based on your age. Decide what percentage of your portfolio you want to invest in stocks, and choose the fund that matches your risk tolerance.
DISCLAIMER
I am a proud nerd (my beautiful wife and daughter told me so) investment and finance blogger, with a Rutgers, MBA and Harvard, Advanced Management. I am a successful investor in equities and real estate and happy to share my personal finance and investment lessons learned with you. I am NOT however, a licensed financial advisor. Please do not construe my suggestions on this blog, as recommendations for your personal situation. For individual finance advice please seek your own licensed CPA or financial advisors.
Staff Writer; Styron Powers
One may visit this brother over at; Powers Investments Management and also connect via LinkedIn; S. Powers.
