Suppose someone told you to build a portfolio, but the upper limit of investments was three. You could pick three stocks, three mutual funds, three ETFs, or any combination of three investments. What three investment vehicles would you select, and why would you pick these three?
None of us wants to be limited to only three investments, but that is the challenge of this assignment. Allan S. Roth wrote an interesting book, "How a Second Grader Beats Wall Street" which is a description of how one can put together a successful portfolio using only three investments. Roth helped his son put together a simple three index fund portfolio. In the 'Second Grader' portfolio, the three investments are:
- Vanguard Total Stock Market Index Fund (VTSMX). We use this fund as one of our benchmarks.
- Vanguard Total International Stock Index Fund (VGTSX). This is another fund we use as our international benchmark in the ITA Index.
- Vanguard Total Bond Market Index Fund (VBMFX).
This portfolio is set up to "Own The World." If limited to three investment vehicles, one of the goals is to "own" as much of the world as possible. The above three index funds do an excellent job.
Since my preference is to hold ETFs instead of index funds, I will alter the above three selections. Here are my three investment choices.
- Vanguard Total Stock Market ETF (VTI) This ETF covers the total U.S. equities market.
- Vanguard FTSE All-World ex-US ETF (VEU). VEU covers the entire world minus the United States equities market. With these two ETFs we have covered the world market.
- iShares Barclays TIPS Bond (TIP). This is an inflation protection bond ETF. Instead of selecting a bond ETF such as BIV or BND, I choose to go with TIP, particularly at a time when inflation is on the rise and likely to increase.
Portfolio construction need not be complicated. An investor who puts 33% in each of the above ETFs has a high probability of outperforming the majority of active mutual fund managers in a given year, and the probability only increases the longer such a portfolio is held. If you are unsure what to do, keep it simple and go with these three ETFs.