If you’re just getting started with investing, an easy way to put your money to work, manage risk, and keep your fees low is to build out a two-fund portfolio.
Two-fund Portfolio: The Basics
A two-fund portfolio is made of two things: a broad market fund, and a broad bond fund. A broad market fund ( also called a total stock market fund) is a fund that, at its simplest, includes stocks from the entire stock market. Basically, they take a full index, like the S&P 500, and build it into a fund that you can purchase, kind of like a stock.
These funds are generally considered safe options. The way it was explained to me is that if the entire S&P 500 shits the bed, you have way bigger problems than what’s happening with your money. Most likely, zombie apocalypse or alien invasion.
Broad market funds can be high-performing as well. The Vanguard 500 Index Fund Admiral is probably the most well-known. In 2007, Warren Buffett famously made, and subsequently won, a bet that hedge funds couldn’t outperform the Vanguard Admiral. That means that a whole bunch of people who are paid millions of dollars to build and manage funds that make people money, still can’t outperform the market as a whole.
Broad bond funds are similar, they just track a variety of bonds. You can read more about them in my blog WTF is a Bond?
Cool, so how much of each?
This question is called “asset allocation” and there are endless opinions on what’s right. Some say the older you get the more you should put into bonds so your money stays safer. Others say you are already safe with a broad market fund. What you choose depends on your own risk tolerance.
For a two-fund portfolio, part of the magic is in rebalancing. When the market dips, you can pull money out of bonds and push it into the market in order to maintain the original asset allocation. By nature, you end up being more likely to buy when the market is lower and then capitalizing on subsequent gains. Keep in mind, there is no guarantee that a particular fund will rise. Investing, by nature, carries risk.
The John Bogle asset allocation model
John Bogle might not be a household name, but he’s very important in the finance world. Bogle founded the Vanguard Group and is credited with creating the first index fund.
Don’t look for the needle in the haystack. Just buy the haystack.
– John Bogle
Bogle also was a proponent of the two-fund portfolio and for his own, he allocated 60% towards the broad market and 40% towards bonds. The exact funds were VTI (market) BND (bonds).
Bogle’s advice was that the percent of the money you have in bonds should roughly equal your age. Personally, I don’t follow that advice, it’s too conservative for my own risk tolerance. But again, how you invest your own money will be unique to you and your own situation.
However, the John Bogle asset allocation model continues to be one considered a prudent way to invest, even after his death in 2019.
The Warren Buffett asset allocation model
Coming back full circle to the Oracle of Omaha himself, the Warren Buffett asset allocation model is significantly less conservative than Bogle’s. Buffett recommends a 90/10 split on a two-fund portfolio.
This advice came to light when Buffett released a letter in 2013 that outlined his plans for his wife’s inheritance. The higher risk model was shocking to some investors in that it contradicted the long-standing advice of Bogle.
A professor from Spain decided to test out the method. He found that not only did Buffett’s asset allocation of 90/10 return high gains than the more conservative 60/40 Bogle asset allocation, it also did not pose a significant risk of portfolio failure (running out of money before you die).
Deciding your own asset allocation
Ultimately, the choice is yours. Be sure to learn as much as you can about allocation, from multiple sources, and use a professional financial advisor you can trust if you have doubts.
Personally, I am driving towards an 90/10 model. When I first built my portfolio I had the help of a financial advisor who put me into high dividend funds. The problem with this is that it takes a lot of maintenance. More than I currently have the time for, so overtime Ill shift money into an 90/10 asset allocation.
What is rebalancing and when should I do it?
Part of the beauty of the two-fund portfolio is its simplicity and ease. The only maintenance you need to worry about is rebalancing. This is simply the process of re-aligning to your asset allocation model.
For example, if you choose to go with 80/20 and invest $1000 today, by next year you may (fingers crossed) have $204 in bonds and $880 in the market, if growth stays at an average rate.
In order to get back to 80/20, you need to shift $13 over to bonds. Now you’re back to 80/20. How often you do this really depends on the volatility of the market and your own goals and constraints, there’s no rule of thumb here.
One last thing… shouldn’t I be more diversified?
Common investing advice is to make sure your investing strategy is diversified. Even people who don’t go deep on investing knowledge are generally familiar with this idea. It’s well known because it is true.
Imagine if 20 years ago you had gone all-in on Blockbuster stock. Or if pre-Katrina you had gobbled up real estate in New Orleans. The future is unpredictable and diversification keeps our money, and subsequently, our futures safe.
Broad market index funds, are by nature diversified. The broader you go, the more diversified you are. The same goes for bonds. Like I mentioned earlier, if all of those things go caput, the problems we’re facing are going to be bigger than money.
Keep in mind that there 5,000 financial indexes in the US alone and not all of them are equal. Do your homework and choose funds that are right for you.
In closing…
Whether you choose the John Bogle asset allocation model, the Warren Buffett model, or something in between, a two-fund portfolio is one of the asset allocation models investors use for long term investing strategies. This asset allocation can be appropriate for beginner investors.
