[Editor's Note: Today's post from the Physician on FIRE is for those who love spreadsheets, love the three fund portfolio, and want to combine the two. I've written before that if you can't use a spreadsheet, you probably have no business managing your own money. This is a critical skill for you to learn and here is another great example of an investing spreadsheet.]
I’ve written a number of times on the effectiveness and beautiful simplicity of a three fund portfolio. All you need to do is own one total stock market fund, one total international fund, and one total bond fund and you’ve got a portfolio that is incredibly well diversified and likely to perform as well or better than many far more complicated portfolios.
There’s a slight problem, though. Nobody, and I mean nobody, has a portfolio this simple.
For one thing, your money is necessarily kept in multiple accounts. You might have a 401(k) or 403(b), perhaps a 457(b), a Roth IRA, SEP or SIMPLE IRA, solo 401(k) and maybe even a cash balance plan. You also invest in a taxable brokerage account once you’ve maxed out those other ones.
Plus, those passive index funds don’t exist as options in all of your accounts. You could be stuck with a Retirement Date fund in one account and some lackluster selection of actively managed funds in another.
And that’s just you. Your spouse has a similar stack of accounts and there’s just no way you can keep track of it all. Well, you can. That’s what the free service offered by Personal Capital is for, but even they can’t compete with the versatility of your very own spreadsheet.
That’s where I come in.
Investing in a Three Fund Portfolio When You Have Numerous Accounts
Many people want to start managing their own money, but they don’t know where to begin. “You need an IPS,” I say. “Build a spreadsheet,” I tell them. Which is about as helpful as telling someone who’s cold to build a sweater. Most people don’t have the time or the skills to do build a portfolio-tracking spreadsheet. Or a sweater, for that matter.
I’m not going to teach you sweater-building 101 (I think it’s actually called knitting if I’m not mistaken) or walk you through the creation of a portfolio-tracking spreadsheet. Sometimes it’s easier to give a fish than to take someone fishing, so I’ve gone ahead and built a highly useful spreadsheet for you.
Balance a Three Fund Portfolio Across Many Accounts
I’m not going to argue that the three fund portfolio is the ideal portfolio — I’ll let Taylor Larimore do that — but I believe it’s a great starting point and a fine endpoint, too.
Before we get to the spreadsheet, let’s talk about asset location and tax efficiency.
A total bond fund is less than optimal in a taxable brokerage account. Bond funds typically spin off more dividends than stock funds and you will pay tax on those dividends. The only bond fund I would consider holding in a taxable account is a municipal bond fund, preferably designed for the state in which I live. I have my total bond fund in a 401(k).
A total international fund is a great option for a taxable brokerage account. The fund will pay some foreign tax on your behalf, and if you hold it in a taxable account, you get a tax credit for that foreign tax paid. When held in a tax-advantaged account like an IRA or 401(k), you will not get any benefit from that credit.
Regarding the total US stock market fund (also somewhat arrogantly known domestically in the US as a total stock market fund), it’s a fine fund to hold anywhere. It’s reasonably tax efficient with a current dividend yield around 2%, and holding some in taxable may give you some tax loss harvesting opportunities.
In summary, I recommend holding the total bond fund in tax-advantaged accounts, international in a taxable brokerage account (if you’ve got one), and the total US stock market in any or all places, with the caveat of tax loss harvesting issues which I will detail below.
You do not need to hold all three funds in each and every account you own. In fact, that makes your life more complicated and is counterproductive when simplicity is what you hope to achieve.
The Three Fund Portfolio Spreadsheet
Taking into account the fact that you are going to have numerous accounts and not all of them will offer the usual three funds, I’ve set up the spreadsheet to give you a taxable brokerage account, two Roth IRA accounts, and four other retirement accounts. You can use this as an individual or as a couple if you have combined finances.
Each account gives you the option of a fourth class, the “alternative” class which could be in real estate like the REIT fund in the Ferri Core Four portfolio, crowdfunded real estate, or other alternative investments such as precious metals or angel investments.
There’s also a spot for a mixed fund that contains elements of multiple asset classes. If you have such a fund, look it up on Morningstar for the percentage devoted to each class. I did not create a separate class on the spreadsheet for cash, which I usually lump in with my bond allocation. If I made this truly a one-size-fits-all spreadsheet, it would have to be much larger and it’s big enough as-is. You will have the option to download and make any modifications you wish.
The white spaces are places for you to enter your information. You can also change the fund and ticker names.
Any numbers in blue or gray will be calculated for you, including the annual cost of owning your funds as long as you enter the correct expense ratios. A weighted average of the expense ratios will be calculated at the bottom.
I’ve gone ahead and entered the tickers for a three fund portfolio from Vanguard, Fidelity, and Schwab in the first three accounts. Note that the Schwab international fund is not a true “total international” fund as it does not include emerging markets like the Vanguard and Fidelity funds.
As you will see, here at the bottom, the percentage of each asset class is calculated for you, as is the dollar amount and percentage by which your portfolio deviates from the desired allocation you set. I defaulted to 50% US / 30% Int’l / 20% Bond. Feel free to adjust those according to your risk tolerance and preference.
The same information is displayed in graphical donuts…. mmmm….. donuts.
To download this spreadsheet, enter your e-mail below and I’ll send it to you. You will be subscribed to the site and within a week, you’ll be given the option for a weekly digest rather than an e-mail with each new post.
Download the Spreadsheet
Tax Loss Harvesting and the Three Fund Portfolio
The main reason I have personally deviated from a three fund portfolio in my own portfolio is the fact that I like to take advantage of tax loss harvesting opportunities. The process is described in detail with screenshots for Vanguard in this post, Fidelity in this post, and I will summarize briefly here.
In my taxable account, I like to swap Vanguard’s total stock market fund for the S&P 500 (VTSAX for VFIAX) and vice versa. I also swap back and forth between two similar but non-identical international stock index funds. Total International (VTIAX) and All World Ex-US (VFWAX) make for good trading partners.
A problem can arise when you own the same funds in your tax-advantaged accounts. If you take a loss on a fund in taxable and have purchased other shares of the same fund in different accounts within 30 days before or after, the value of the purchased shares is disallowed from the loss you report. This is known as a “wash sale.”
The good news is that the entire loss is not forbidden — only the dollar amount that you invested in that window. If you’re investing biweekly or reinvesting dividends quarterly, it’s easy to inadvertently create a wash sale if you are investing in funds you own in the taxable account and plan to tax loss harvest. Trust me. I’ve done it.
To avoid this situation, I’ve chosen to own small and mid cap indexes in my tax-deferred accounts. My taxable account has the funds mentioned above and none of those are owned anywhere else in my portfolio, including our Roth IRAs, 401(k), 457(b), and even the HSA.
While it’s true that the IRS hasn’t spelled out exactly what constitutes a wash sale (although I believe they have said a purchase in your IRA or spouse’s IRA counts), I think it’s best to avoid gray areas.
If you’d prefer to stick with total stock market funds for your US stock allocation, the Vanguard fund tracks the CRSP US Total Market Index and the Schwab fund tracks the Dow Jones US Total Stock Market Index. Since the holdings are not identical, it could certainly be argued that these are not substantially identical.
For further reading on the three fund portfolio, check these out:
- He Has Read Over 250 Investing Books. He Recommends These Three Funds.
- From 28 Funds to 3: Simplifying to a Three Fund Portfolio
- A Vanguard Three Fund Portfolio Just Got Cheaper!
- Investing in a Three Fund Portfolio Across Numerous Accounts. Get the Spreadsheet!
- The Bogleheads Guide to the Three Fund Portfolio
Does this look like something you can handle? If you were to veer from the three fund portfolio, in what direction would you go?
I read with interest your recommendations of preferring a municipal bond fund (preferably from your state in residence) in preference to a total bond index fund in taxable accounts. What if you live in a state with budget shortfalls, underfunded state pensions, etc. and similar problems in its municipalities. I currently own a total bond index fund in a taxable account and I am reluctant to switch to a municipal bond fund from my state because of the poor finances (I live in New Jersey). Should a states finances factor into this decision or am I being overly cautious?
Good question, MM.
It’s one of those decisions at the margins — whether you own munis or not won’t make or break you. In general, non-muni bond funds are not tax-efficient, but with the low yields we’re seeing today, it’s not terrible to own a total bond fund in taxable (even if it is suboptimal).
I own my total bond fund in tax-deferred accounts. If you were going to start buying munis in taxable, you might be more comfortable owning a fund not specific to any state to spread out that risk. You would lose the benefit of the fund being state-income-tax-free, but that’s a tradeoff I’m guessing you’d be willing to make.
Cheers!
-PoF
If you have serious concern about your state defaulting, then no, use a national fund for at least part of it. Or just put TBM in a tax protected account and put stocks in taxable.
Can someone give an example of a taxable account? I think I understand that a 401k, Roth IRA are tax advantage accounts but what is an example of a taxable account? Are these primary when you max out your retirement accounts through your employer?
Like a simple brokerage or mutual fund account at Vanguard, Fidelity, or eTrade. Basically any investment that isn’t in a 401(k), Roth IRA, HSA etc is in a taxable account.
1 suggestion and 1 question:
1. Suggestion: Why not make it a 2 Fund Solution by using VT for all global equities instead of VTI and VXUS? VT is cap weighted around the world in one low-cost fund. I don’t think VT existed or was very prevalent when Taylor Larimore wrote his book.
2. Question: Regarding tax-efficient location of assets between taxable and non-taxable retirement accounts, I have debated if Foreign Equities should be in the taxable account to claim the foreign taxes paid or not. The drawback to putting Foreign in the taxable account is that Foreign Equity has a much higher dividend rate than U.S., thus more taxes are due on the larger dividend amount received each year. Have you compared the benefit to claiming the foreign taxes paid versus the taxes owed on the higher dividends to confirm that is most tax efficient?
Thanks. Always enjoy your WCI posts.
1. Why not one fund with a simple Life Strategy fund? Different strokes for different folks.
2. It’s basically a wash between TISM and TSM in taxable for the reasons you state. If that’s your biggest portfolio dilemma, you already won this game.
Would you guys please clarify why Jim says bonds go in taxable
https://www.whitecoatinvestor.com/asset-location-bonds-go-in-taxable/
https://www.whitecoatinvestor.com/rethinking-bonds-in-taxable/
https://www.whitecoatinvestor.com/my-two-asset-location-pet-peeves/
and Physician on Fire says, “A total bond fund is less than optimal in a taxable brokerage account?”
If you read that third link, you should figure it out. You’ll notice if you read carefully that I never really said bonds go in taxable. Certainly I never said that a high earner should put taxable bonds in taxable. I said there are some situations, especially at low interest rates, when it is fine or even preferable to put bonds in taxable. Last I checked, POF agreed with that analysis.
But both POF and I certainly agree that a total bond fund in taxable is a bad decision for someone in a high tax bracket.
You’ve got to read more than the headlines. They’re just clickbait anyway.