3 FUND PORTFOLIO FOR BUSINESS OWNERS

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Have you heard of Occam’s razor? Here is a formal definition.

“... a scientific and philosophical rule that entities should not be multiplied unnecessarily which is interpreted as requiring that the simplest of competing theories be preferred to the more complex or that explanations of unknown phenomena be sought first in terms of known quantities.” (You can read more about Occam’s razor here provided by University of California Riverside.)

Not everyone has an interest in ancient principles or For those of us who did not specialize in quantum mechanics or philosophy, there is a straightforward definition.

The simple solution to a problem is more likely to be correct than a more complex solution for the same problem. When there are additional layers of complexity, there is a higher likelihood one of the layers creates an issue or causes the theory/process to lose efficacy.

Basically, simple is probably better. This can be broadly applied - to owning a business, investing and beyond.

Have you heard of Sturgeon’s law?

It is an adage stating, “90% of everything is crap.”

It doesn’t take a “rocket surgeon” to figure this one out. The aphorism suggests the vast majority of outputs in any given field are likely to be of low quality. For example, in the music industry, Sturgeon’s law suggests that 90% of the songs produced and published each year are bad. Most of the music probably isn’t worth the time it takes to listen.

The principle probably applies to nearly every industry, and definitely business plans, investing theses, and financial planning. Many outputs/solutions will be ineffective at best or downright terrible at worst.

Sturgeon’s law is a useful rule of thumb to keep in mind, since it can improve the way you assess and consume information, as well as the way you decide what to work on or invest in.

Basically, 90% of everything does not meet basic standards of quality, and simple solutions are the best solutions. Is there a way to manage your portfolio that satisfies both of these principles/maxims?

Let’s examine a 3 fund portfolio. Perhaps it will simultaneously be a simple and effective solution for business owners and other investors.

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What is a 3 fund portfolio?

A 3 fund portfolio uses only basic asset classes/funds - typically a domestic stock "total market" index fund, an international stock "total market" index fund, and a bond "total market" index fund.

Your portfolio is simply an investment account or set of investment accounts. You can establish a 3 fund portfolio in any single account or across the entirety of your invested assets.

Total market simply means the fund will passively invest in a broad basket of the components that make up the asset class. There isn’t much buying and selling of the components (e.g., stock or bonds) within the fund.

You use either mutual funds or ETFs to set up your 3 fund portfolio. All of the major fund companies and/or brokerage firms will have the funds you need on their platform. You can mix and match between the different fund providers or utilize a uniform set of funds.

The actual mechanics of establishing a 3 fund portfolio is relatively simple. Once your account is opened and funded, you will purchase the mutual funds or ETFs in predetermined proportions/percentages.

How do you choose what percentage to allocate to each of the 3 funds?

Your age, years until retirement, and general risk tolerance will determine your allocation to each asset class.

If we were to rank the asset classes from most risk exposure to least risk exposure, it would be as follows: international equities, domestic equities, and bonds. Your total portfolio may allocate to each asset class in one of the broad methods below.

A relatively aggressive allocation (an 80/20 portfolio) e.g., 64% U.S. stocks, 16% International stocks and 20% bonds

A middle-of-the-road allocation (an equal weight portfolio) e.g., 33% U.S. stocks, 33% International stocks and 33% bonds

A relatively conservative allocation (a 20/80 portfolio) e.g., 14% U.S. stocks, 6% International stocks and 80% bonds

The allocation decision will be entirely based on your unique circumstances. If you need a lift or have questions, reach out to a financial advisor. They should easily be able to help you determine which of these allocations or another would be right for you.

What are the advantages of a 3 fund portfolio?

1/ A quick path to diversification

Diversification is an important element in portfolio construction. A certain amount of risk can be reduced or entirely eliminated through diversifying your dollars across different asset classes.

Not only is each individual index fund or ETF broadly diversified, the three components together offer additional diversification.

A 3 fund portfolio will provide the necessary diversification you’ll need as a business owner/individual investor.

2/ The low cost nature of passive funds

The annual fee you pay to own a mutual fund or ETF is known as the expense ratio, expressed as a percentage of fund assets.

The funds used to create the 3 fund portfolio are typically among the cheapest (i.e., lowest expense ratios) available to investors. With these types of passive funds, the fund provider will have only a few duties related to managing the funds so there will be fewer administrative costs.

Passively managed funds simply try to replicate the performance of index rather than trying to beat the market.

The performance of any mutual fund or ETF is correlated with the expense ratio. Generally speaking, a lower expense ratio fund is advantageous to the individual investor.

3/ The simplicity of creating/managing your portfolio

You will make a few initial decisions, but each step requiring your attention will have an uncomplicated solution/answer. The process of creating a 3 fund portfolio is quick and easy.

If you need any assistance, a competent financial advisor would be able to quickly address any questions you might have. As a business owner, sometimes it is nice to have someone to take over the entire process.

Over the long-term, managing your 3 fund portfolio will be more of the same in terms of simplicity. At certain times, you may be required to rebalance (i.e., adjust the allocation percentages to each fund, returning them to the original or desired percentage) your portfolio. This process will be mostly painless.

Is it really that simple?

Absolutely.

You won’t break any records or achieve absurdly high rates of return, but you will have a simple strategy in place. There will always be other portfolio options for individual investors but few will be as simple as the 3 fund portfolio.

No strategy is perfect.

That being said, it would be difficult to find a plan for your portfolio that is simultaneously as simple and effective as a 3 fund portfolio.

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TL;DR

It is easy to make portfolio management complex, but usually the simple solution is the best solution. (Occam’s Razor)

In any industry, 90% of the outputs or ideas are crap, even in financial planning/wealth management. (Sturgeon’s Law)

The 3 fund portfolio might be a way to avoid the pitfalls of a complex or ineffective portfolio strategy.

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Maybe you already use the 3 fund portfolio or something similar. If that’s the case, you understand how simple it is in action.

Share this post with another business owner or investor who might benefit from the simplicity of the 3 fund portfolio.