John Bogle, in his speech, “Investing With Simplicity,” states:“Simplicity is the master-key to financial success. When there are multiple solutions to a problem, choose the simplest one.”
Simplicity can take on a number of forms in the art of investing. These include both the mechanics of saving and investing; in establishing a portfolio of financial assets; and in managing these assets.
Simplicity in saving and investing
“Truth is ever to be found in the simplicity, and not in the multiplicity and confusion of things.” – Issac Newton
Sound investment principles direct us to set up a regular savings and investing process by living below our means and starting our investment journey as early as possible. Automating our savings and investments is often helpful. This can be done with regular salary deferrals in company provided retirement plans, and also with regular periodic investments into personal accounts.
Balanced investment portfolios consisting of risky equity investments combined with more stable fixed-income investments serves to temper the ups and downs of the financial markets at acceptable levels so that we can “stay the course” through buying, holding and rebalancing the portfolio.
The best way to gain a fair share of market returns is by limiting investment costs and reducing tax costs.
These goals are best met by using index funds as the core of our investment portfolio.
Simplicity in building a portfolio
John Bogle delivers a simple dictum applicable to every investor:
“The central task of investing is to realize the highest possible portion of the return earned in the financial asset class in which you invest—realizing, and accepting, that that portion will be less than 100%.”
This dictum can be realized by utilizing one of a number of simple portfolios.
One-fund solution
60/40 balanced fund allocation
A single low-cost indexed balanced fund can serve as a suitable investment portfolio for many investors. A low-cost indexed balanced fund supplies investors with 99% of the market return.
Balanced funds are best used when the bulk of an investor’s assets are held in tax-advantaged retirement accounts.
Two-fund solution
40/60 total world/ total U.S. bond allocation
Investors can capture almost all the U.S. stock market return by investing in a total stock market index fund and combine it with an intermediate-term or short-term bond fund.
If an investor is comfortable with global stock market capitalization weighting, a total world stock market index fund can fulfill the equity allocation in a two-fund portfolio.
Three-fund solution
40/60/Three-fund allocation
The three-fund portfolio is a popular portfolio with many investors. The three-fund portfolio consists of three total market index funds:
- U.S .total stock market index fund.
- International total stock market index fund.
- U.S. total bond market index fund (or intermediate tax-exempt bond fund for high-tax situations when bonds are held in taxable accounts).
Four-fund solution
20/80/Core four allocation
Core four portfolios add a fourth asset class to the three-fund portfolio. The additional asset class may include:
- International bonds. The Vanguard Lifestrategy and Target Retirement funds add an international bond market index fund to the three-fund portfolio mixture.
- REIT stocks. Author Rick Ferri adds real estate investment trusts to the three-fund portfolio.
- Inflation-indexed bonds. Some investors may wish to add U.S. inflation-indexed bonds to the nominal bonds held in the three-fund portfolio.
Advantages to a simple approach
“Simplicity is the ultimate sophistication” – Leonardo da Vinci
Simplifying the investment process benefits us by:
- Reducing the time and effort needed to manage our financial affairs and investment portfolios. We can devote our time to the important and meaningful aspects of life.
- When it comes time to transfer the management of our finances (by incapacity or death), simplifying the investment process makes it easier for our beneficiaries to continue managing the finances.
Next post in the investing basics series: Staying the course
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