Many people think success in the stock market is unachievable for the average person. The idea that extensive research needs to go into each and every stock pick — and the fear that inadequate research could result in significant losses — keeps many from investing altogether.
But investing doesn’t have to be a difficult process.
In fact, a simple portfolio made up of a few low-cost index funds will give you the ability to take part in the wealth-building powers of the market. One of the most popular of these simple portfolios, also known as lazy portfolios, is the Bogleheads Four-Fund Portfolio.
What Is the Bogleheads Four-Fund Portfolio?
As its name suggests, the Bogleheads Four-Fund Portfolio was developed by John C. Bogle, also known as Jack Bogle, the founder of the Bogleheads forum at bogleheads.org. The portfolio is incredibly simple to create and manage due to its limited need for multiple assets.
There are, in fact, only four index funds and exchange-traded funds (ETFs) needed to duplicate the portfolio.
The portfolio is similar to another of Bogle’s portfolio designs, the Bogleheads Three-Fund Portfolio. The only difference between the two is added allocation to international stocks, something the three-fund portfolio lacks.
However, this international exposure makes a big difference in terms of overall returns.
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Portfolio Asset Allocation
The portfolio model suggests investors should spread their money across four investment-grade funds, each providing exposure to a different asset class. The allocation in the portfolio is as follows:
- 60% in U.S. Stocks. The portfolio is heavily tilted to the United States market, with 60% of the assets in the portfolio being allocated to this class. The fund you choose should have a low expense ratio and provide coverage to the U.S. market as a whole by investing in stocks with ranging market caps across various sectors.
- 20% in International Stocks. The portfolio also places value on international investments, with 20% of its allocation being pointed to stocks outside of the United States. As with the domestic holdings, the ETF that represents international holdings should be highly diversified, offering a valid representation of stocks in various sectors, market caps, and regions around the world.
- 15% in U.S. Bonds. To add stability to the portfolio, Bogle brought fixed-income investments into the equation — 20% in all, three-quarters of which is allocated to U.S. bonds. Although the portfolio strategy doesn’t tell you whether these should be corporate or Treasury bonds, the government bond route is important to consider for added stability in this low-safe-haven-allocation portfolio.
- 5% in International Bonds. The other quarter of the safe-haven allocation, or 5% of the overall portfolio, is invested in international bonds. Again, due to the low safe-haven allocation in this portfolio, it’s best to keep the risk on these bonds to a minimum, choosing a bond fund that offers diversified exposure to government debt in different regions around the world.
The Investment Thesis Behind the Portfolio
Sure, the portfolio only includes four investment-grade funds, but the investment thesis behind the portfolio is multifold:
A Focus on Simplicity
As with the Bogleheads Three-Fund Portfolio, this portfolio model is proof that participating in the activities on Wall Street doesn’t have to be a difficult process.
With this investment strategy, investors have the ability to tap into the gains the market has to provide with a minimal time commitment, even if they don’t completely understand how the market works.
With only four investment-grade funds in the portfolio, you may be surprised to find that the strategy is actually one that’s born in diversification, both on an asset level and on an individual investment level.
By investing in total U.S. and total world index funds, your portfolio gains exposure to thousands of stocks, both domestic and international. Not to mention, these stocks will have wide-ranging market caps and operate in nearly every corner of every sector of the global economy.
This level of diversification offers protection against volatility in your portfolio, resulting in less risk than you would have to accept if you invested in fewer assets.
Finally, Bogle didn’t put much of the allocation of this portfolio to safe-haven assets, but what he did include is meaningful. Bond allocation represents 20% of the portfolio’s overall allocation, with 15% in domestic bonds and 5% in international bonds.
Should the global market take a hit, these bonds will provide a level of stability, helping to ease the blow for the investor.
Pros and Cons of the Bogleheads Four-Fund Portfolio
As with any other financial decision, it’s important to consider the pros and cons when deciding whether to invest using Bogle’s Four-Fund strategy. After all, when you’re talking about making, losing, or spending money, there’s never a one-size-fits-all approach.
Bogleheads Four-Fund Portfolio Pros
The Four-Fund strategy is popular among investors, especially those on the Bogleheads forum. No investment strategy becomes popular without performing well and fitting the needs of a group of investors.
The reasons this portfolio strategy has become so popular include:
- Performance. Historically, the performance of the portfolio has been solid, consistently outperforming the S&P 500 index, albeit by very little. Consistently outperforming the S&P is a difficult task, but possible with little-to-no difficulty at all using this strategy.
- Simplicity. Calling this a lazy portfolio is somewhat of an understatement. The portfolio only requires investments in four funds coupled with a limited need for rebalancing. There are very few portfolios that are as easy to set up and manage as this one.
- International Exposure. One of the big draws for this portfolio strategy is its heavy tilt toward international stocks. In terms of total market cap, the U.S. only represents about 50% of the global market’s value. The international exposure allows you to tap into the other 50%, which has quite a bit to do with the portfolio’s outperformance of domestic benchmarks throughout history.
Bogleheads Four-Fund Portfolio Cons
With these perks in mind, you might think you’re ready to dive in. However, the grass isn’t always as green as it appears from the other side of the fence.
The most important drawbacks to consider before buying into the Four-Fund Portfolio include:
- Risk. This portfolio has the potential to outperform the market, as it has in the past. On the other hand, historic performance isn’t always an accurate prediction of future results, and this portfolio is a pretty risky one. After all, only 20% of the allocation in the portfolio is aimed at safe-haven assets, which is a bit too light for most investors.
- Lack of Control. Any portfolio made up of investment-grade funds limits your control, both in terms of the stocks you invest in and your voting rights as a part-owner of the included companies. If you’re interested in making your vote count or choosing your own individual stocks, this isn’t a great portfolio strategy to follow, as is the case with any other prebuilt portfolio centered around index fund and ETF investing.
- Painful Drawdowns. When the market takes a dive, so too will your investments. Historically, drawdowns in the portfolio have been as painful, if not more so, with this equity-heavy strategy.
Who Should Use the Bogleheads Four-Fund Portfolio?
As with most portfolio strategies, the Four-Fund strategy was designed for a specific group of investors. Again, there’s no one-size-fits-all approach to finances. Those who would benefit most from this investment strategy include:
1. Young Investors With Long Time Horizons
The Four-Fund strategy is a high-risk/high-reward approach to investing, which makes a huge difference in who should consider using it. Younger investors with long time horizons should be more willing to accept risk, as they have plenty of time to make up losses should a significant drawdown take place.
On the other hand, investors who are nearing retirement, living off their investments, or have a short-term — or even mid-term — time horizon should avoid this strategy like the plague. Should a correction or bear market take place, this portfolio is likely to tank, and without plenty of time to make up the losses, recovery may never happen.
2. Investors With a Healthy Risk Tolerance
Even some young investors with all the time in the world to make up for losses would find this portfolio strategy to be a bit too risky. Only 20% of the portfolio is invested in fixed income, a quarter of which is in international fixed income assets, which are less stable.
Risk-averse investors should choose an investment strategy that’s more fixed-income heavy but uses diversification to generate meaningful returns with their investment dollars. The Gyroscopic Desert Portfolio is a great low-risk option to consider for the risk-averse investor.
3. Investors Who Don’t Have a Ton of Time
Many investors who use an equity-heavy portfolio strategy prefer making their own investment decisions rather than using investment-grade funds.
However, if you aren’t well versed in market research or simply don’t have the time to do the research it takes to maintain a well-diversified portfolio, but you want access to market-leading returns, this may be a great option.
How to Duplicate the Bogleheads Four-Fund Portfolio
Because the portfolio only calls for allocation in four different low-cost index funds, it’s a very simple one to recreate. However, you may want to consider small tweaks to the allocation to fit your specific investing style.
Here are a few different renditions of the portfolio:
The Traditional Bogleheads Four-Fund Portfolio
The traditional portfolio can be put together using four popular Vanguard funds. These funds include:
- 60% in Vanguard Total Stock Market Index Fund ETF (VTI). The VTI fund invests in a diversified group of domestic stocks. The holdings in the portfolio range from small- to large-cap and are spread across various sectors.
- 20% in Vanguard Total International Stock Index Fund ETF (VXUS). The VXUS fund offers diversified exposure to the international stock market, investing in both developed and emerging economies, and excluding the United States. Like the VTI fund, its investments include a broad range of market caps and sectors; they’re also well-diversified from a geographical standpoint.
- 15% in Vanguard Total Bond Market Index Fund ETF (BND). The BND fund invests in a wide range of U.S.-dollar denominated bonds with the exclusion of tax-exempt bonds and inflation-protected securities. Bonds held in the portfolio are intermediate-term, with maturities ranging from three to 10 years.
- 5% in Vanguard Total International Bond Index Fund ETF (BNDX). The BNDX fund is similar to BND, but instead of investing in domestic bonds, it invests in bonds from around the world, helping bring international exposure to your fixed-income allocation.
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The Small-Cap Value Four-Fund Portfolio
Recently, there’s been a spotlight put on factor investing, which is simply the process of investing in index funds that come with factors that pay a risk premium. One of the most popular asset classes among factor investors is the small-cap value, which pays a risk premium for the small size of the company as well as the low valuation of the stock.
If you want to mix in some small-cap value, you can do so by making one small change to the portfolio. In an effort not to increase risk too much in this already risk-heavy portfolio, you would want to cut the 20% exposure to the VXUS fund in half.
Invest this 10% allocation in the Vanguard Small-Cap Value Index Fund ETF (VBR). This is a domestic fund that only invests in companies with small market capitalizations that display strong value characteristics. As a result of this change, you can expect to see a small bump in your overall return without any significant increase in risk.
The Income Four-Fund Portfolio
Another rendition of the portfolio helps to address its risk. You can add some stability to your equity holdings by focusing on large-cap dividend-paying companies.
These companies have generally been in business for quite some time and have proven business models that are relatively predictable. As a result, these companies are able to share their profits with investors by way of dividends and share buybacks.
Moreover, the relative predictability of these stocks makes them a great hedge against risk in an equities-heavy portfolio.
To turn the strategy into a more stable income strategy, all you’ll need to do is replace the VTI and VXUS allocations with the following:
- 60% in Vanguard High Dividend Yield Index Fund ETF (VYM). The VYM fund invests in a highly diversified group of domestic stocks known for paying high dividend yields. While these stocks will generate slower growth than those in the VTI fund, they also provide compelling dividend payments and more stability, making them a perfect option for the risk-averse investor.
- 20% in Vanguard International High Dividend Yield Index Fund ETF (VYMI). VYMI is an ex-U.S. fund, meaning it doesn’t invest in any U.S. securities. Instead, it has an international focus on stocks known for paying high dividend yields, which brings more stability into the equity allocation of the portfolio.
The Real Estate Four-Fund Portfolio
Real estate has become a hot topic in recent years. With prices skyrocketing, many want to get their hands dirty in the industry, but purchasing and renovating a property is too expensive for many individual investors.
Nonetheless, the stock market is packed with real estate investment trusts (REITs). These are companies that acquire and manage real property and rent it out to tenants for a profit.
These companies pool funds from the investing community to cover the cost of property acquisitions, renovations, and management, ultimately sharing profits with shareholders as tenants pay their rent.
If you’re interested in giving the portfolio exposure to real estate, consider replacing the 20% allocated to the VXUS fund with the Vanguard Real Estate Index Fund ETF (VNQ). The real estate index fund invests in a diversified group of REITs that own and operate many different types of real property ranging from apartment buildings to cellular towers and everything in between.
Keep Your Portfolio Balanced
Any prebuilt investment portfolio is going to be built with a specific balance in mind. This balance is extremely important because it helps to ensure your portfolio isn’t overexposed to risk or underexposed to opportunity.
However, prices change in the market on a second-by-second basis. Over time, some prices change faster than others, resulting in your portfolio falling out of balance according to your portfolio strategy. Regular rebalancing is a must, especially when your portfolio has a heavy allocation to equities.
This particular portfolio won’t require you to rebalance daily or weekly, but it is a good idea to take a few minutes once per month to make sure everything’s in line with the strategy, providing both the protection and exposure to the opportunity it was designed for.
Sure, the Bogleheads Four-Fund Portfolio is a risky one when you consider the heavy allocation to stocks. However, along with risk often comes reward in the stock market, and that has historically been the case with this strategy — it’s one of few with a consistent history of outperforming the S&P 500 index.
On the other hand, no matter how exciting the prospect of beating the market may be, those with shorter time horizons should avoid this portfolio strategy because the risk ultimately outweighs the potential rewards.
Moreover, with so few assets involved in the strategy, this is a simple one to customize. Just make sure you take the time to do your research and get a full understanding of what you’re buying before doing so.