VTSAX + VBTLX + CASH = World's Simplest 2-Fund Portfolio
In search of the perfect portfolio with perfect investments, we often overcomplicate our investing and personal finance strategy. Ever heard of Ray Dalio’s All Weather Portfolio, the Coffeehouse Portfolio, or Dave Ramsey’s Four Fund Portfolio? If you scour the web, there are literally endless lists of portfolio ideas that all espouse why one is better than the other.
“The greatest enemy of a good plan is the dream of a perfect plan.” - General Clausewitz
Simplicity is one of the most overlooked and underrated vocabularies in the American dictionary. We subconsciously doubt when an answer to a complex problem seems so simple., and this is especially so true when it comes to investing.
The financial media has done a great job of making it seem like investing should be complex and difficult. It’s created an illusion that if we are to do more work, more research, and more digging, we will find the secret elixir of a perfect investment portfolio that will make us millions.
However, the brutal truth is this. The more complex an investment is, the less likely it is to be profitable and to pop the bubble even more, there is no such thing as a perfect plan. Only a plan that just works, and works for you. This is where I want to introduce to you the simplest investment portfolio in the world. Two simple index funds and a checking account.
The Tools
Equities - The number one tool is an equities fund. And my personal favorite here is the Vanguard Total Stock Market Index Fund, also known as VTSAX. Stocks will act as your core wealth-building tool. The engine that will propel your money forward towards the magic of compounding.
Bonds - The number two tool is a bond fund. And my personal favorite here is the Vanguard Total Bond Market Index Fund, also known as VBLTX. Bonds will help smooth out the rough ride of stocks. Sort of like your breaks that you can tap here and there so you don’t run yourself off the road. Now a caveat here is that if you are in your 20 or even 30s, you don’t even need to worry about bonds at this stage. This comes more into play later as you get closer to your retirement age.
Cash - The number three tool is cash. Cash in my books is one of the most underrated tools because people judge it based on its asset class. Cash doesn’t make you more money. It just sits there paying the bills. Thus people dismiss its power and tend to downplay its importance. However if you’ve watched any of my other videos, you know I love cash. Not only because it pays the bills but because it provides so many other benefits like the ability to handle emergencies, to buy opportunities, and my favorite, emotional peace.
That is guys. The simplest wealth-growing portfolio in the world. Two index funds and a checking account. If you just want the takeaway you can turn off my video here. But if you like to hear my rationale behind this portfolio structure, please watch on.
Why VTSAX?
Real Companies - The number one reason is that when you are investing in broad market equities funds you are investing in real publicly traded companies. And the broader the index, the more companies in your portfolio.
When you buy stocks, you're doing more than purchasing little pieces of paper. You own a piece of that company and you are investing in its future success. The businesses and people behind these companies work tirelessly to serve their customers and maximize their profits. They are constantly competing against others in their field and only the strongest and best companies survive. And it is because of this cutthroat environment that stocks have become one of the most powerful and successful investments throughout history. And you don’t need to look far to see the proof of this power.
S&P 500 Last 100 Years
Just take a look at the S&P 500 over the past 100 years. The 500 largest companies in the United States. The trend is up because American companies are working hard to create value for their customers. But you might be asking, why is investing in an index fund the best way to tap into this amazing growth? Shouldn’t I just purchase the great companies on my own? Buy shares of Apple, Netflix, and Amazon? My answer is no. This is where the second major benefit of investing in index funds comes in. The mechanism of self-cleansing.
Self Cleaning - Yes, American companies as a group are great. They create new products and values. However, to know which specific companies will do or not do well is almost impossible. Blockbuster was one of the most profitable and popular video stores throughout the '90s and early 2000s. At its peak in 2004, it boasted 9,000 stores globally and it earned $5.9 billion in revenue. However, within a few years, it started to lose its popularity and in 2010, the rental company filed for bankruptcy.
What is ironic is that in 2000 Blockbuster was even offered the option to buy Netflix for a bargain price of $50 million dollars. Foolishly they passed on the deal because of their own pride. As we all know Netflix went on to become the company that it is today. A hundred billion dollar giant that’ is synonymous with single-handedly bringing streaming media to the public mass.
But if anyone of us went back to the year 2000 could any of us have honestly been able to guess how and where Blockbusters and Netflix would have ended up? I think not. And this is where the mechanism of self-cleaning of index funds is so important. We want to reap the benefits of a company like Netflix, however, none of us has a magic ball to know what company will one day be the next Netflix. Not a problem because an index fund like Vanguard Total Stock Market Index Fund automatically recycles fading away companies with new ones. The market is not stagnant. It is fluid and the index fund’s self-cleansing mechanism incorporates that fluidness into the fund.
When a company like Blockbuster loses value and goes bankrupt, it automatically gets cleansed from the index. But new companies like Netflix are taking their place. And the upper limit to its growth is limitless. In the last 20 years, Netflix had a total return of almost 23,000% (22,625%). Because the lowest a bankrupt can go is 0 and there is no upper limit to growth, the net result of a broad market index fund like VTSAX is an upward bias. To the right and up. If we were to model all 4,000 companies in VTSAX we’d find that as some previous big stars like Lehman Brothers faded away, but new companies like Tesla grew, prospered, and took their place.
But note that this only works with broad-based index funds, not actively managed funds. Once fund managers get into the mix and try beating the index, this mechanism of self-cleansing goes out the window. Most often these busy fund managers make things worse by trying to pick winning stocks - which not many can do effectively. And the worst of all is that they charge more to do so. Stick with index funds and gain all the benefits of investing in the market while paying less.
Why VBTLX?
Now let’s discuss why you might also want some bonds in your portfolio. Especially as you get closer to your retirement age, and why a broad bond index fund like the Vanguard Total Bond Market Index Fund, aka VBLTX is all you need. Bonds' purpose in your portfolio, as I mentioned earlier, is to really help smooth out any bumpy rides in the stock market. But it also provides a deflation hedge. Deflation occurs when the price of goods spirals downward and inflation occurs when they soar.
Unlike stocks where you are buying a part ownership in a company, when you buy bonds you’re loaning money to a company or government agency. Since deflation occurs when the price of stuff falls, when the money you’ve lent is paid back, it has more purchasing power. This increase in value helps to offset the losses deflation will bring to your other assets.
In times of inflation, prices rise and money owed to you loses value. When you get paid back your cash buys less stuff. It’s better to own assets, like stocks, that rise in value with inflation. Now the risk mitigation concept is great but there are a lot of risks you have to mitigate with holding bonds. For example default risk. What happens when you loan money to someone when they decide to default and not pay you back? Or how about the interest rate? When the interest rate rises, like it is doing right now, bond prices fall.
A way to mitigate all these risks while still gaining the benefit of holding bonds is to hold broad-based bond indexes like the Vanguard Total Bond Market Index Fund, aka VBLTX. It holds over 10,000 (10,174) varying bonds such as U.S. Treasuries and mortgage-backed securities of all maturities (short-, intermediate-, and long-term issues). With this single bond fund, you get broad exposure to the U.S. investment-grade bond market. The greater the broad exposure to a diverse set of bonds, the lesser the risk.
Why Cash?
Alright, let’s talk briefly about why I’m also talking about cash in this post. And personally, I believe you should hold more than you might feel comfortable. The reason is I believe cash provides additional benefits than just covering routine expenses and meeting emergencies. They provide you a cushion for you to think about life in a broader term. If you have enough cash in your bank account to fund your life for a year, you’d be amazed at the brain space you have to pontificate about your future and strategically make the next move. But when you don’t have enough cash, you don’t have a cushion in your life. And when you don’t have a cushion, you could make irrational decisions.
Do you know what the recommended protocol for trying to help someone that is drowning is? It is not to jump in the water to help him or her. What is recommended is that we should try to reach the person with something rigid like a pole. Not our arm. Or throw him or her a rope and encourage them to grab on. And the reason for this recommendation is that drowning individuals are probably the most dangerous persons to try to rescue. In a panic, drowning individuals are likely to claw at rescuers and climb to the surface at all costs. And like a drowning person, when we are in a financially vulnerable and desperate position, we can’t think straight.
Thus the perpetual downward spiral of bad decisions can put us in a worse and worse financial situation. When you have enough cash in the bank account to weather a year of unemployment or market downturn, you have the time. Time to think. Time to plot your next move. And time to make your best financial decision. Don't see cash sitting in your bank account as just losing value. See it as more than that. Your bodyguard, fitness trainer, and thought partner. That is why I consider cashing your third leg to your investment strategy.
Sample Allocation by Life Stage
Alright, with all that said let me share some sample portfolio allocations with the two index funds by life stage.
Wealth Accumulation Phase - The first sample portfolio allocation is for the wealth accumulation phase. For many of us, this phase of life is when we are in our 20s and 30s. We still have a long career ahead of us and withdrawing from our portfolio is still many years away. During this stage, the recommendation is to be 100% in stocks. 100% VTSAX. Yes, 100% of stocks is considered a very aggressive investment allocation. However, when you are young you should be. You have decades ahead to invest and market ups and downs should just be noise to you. You should be excited for market dips during this phase because they are great buying opportunities to scoop up more shares of VTSAX at a lower price. That said if you are still very nervous about a 100% stock allocation, no judgment here. Add a bit of VBTLX to smooth out your ride. In the long run, it shouldn’t make too much of a difference as long as you keep it to a moderate allocation.
Transition Phase - The second sample portfolio allocation is for the transition phase. For many of us, this phase of life is when we are in our 40s and 50s. Retirement is not right around the corner, but you can see it coming. During this phase, I would recommend sprinkling in a bit of VBLTX to get used to holding bonds in your portfolio. Maybe start with 5% the first few years, then up it to 10%. You want to start transitioning from a 100% stock-heavy portfolio at this stage so you can get ready for the wealth preservation phase of your life.
Wealth Preservation Phase - The third sample portfolio allocation is for the wealth preservation phase. For many of us, this phase of life is when we are in our 50s and 60 plus. We’ve built our wealth so now we want to preserve it to fund our lifestyle going forward. This is where you can ramp up bond holding to 25%. So you are 25% VBTLX and 75% VTSAX. If you are even warier of volatility, maybe even 30% VBTLX to 70% VTSAX, or 40% VBLTX to 60% VTSAX. Though for me this might be too conservative. But who knows right? When I get to this stage I might have a very different perspective on risk. I’ll keep you posted.
Alright now that we’ve covered some sample portfolios with these two funds, let me talk about some commonly asked questions with this super simple investment strategy.
VTSAX & VBTLX Alternatives
One is what if I want to find alternatives to VTSAX and VBTLX because you can’t buy Vanguard? Or you want to stay with other investment firms like Fidelity or Schwab because you’ve been doing business with them for many years. What are my options? VTSAX is the best option for total stock market index investing at Vanguard, but there may be fees associated with buying Vanguard mutual funds such as VTSAX at other brokerages such as Fidelity or Schwab. So let me share with you some excellent alternatives to VTSAX at these investment firms.
Fidelity Equities Alternatives
If you are invested with Fidelity, you actually have two options. The Fidelity Total Stock Market Index Fund, FSKAX, and Fidelity ZERO Total Stock Market Index Fund, FZROX.
FSKAX has been around much longer and has very similar returns to VTSAX. It also has a slightly lower expense ratio than VTSAX at 0.015% and tracks the Dow Jones US Total Stock Market Index.
FZROX is the new kid on the block and made big news when they offered the first mutual funds with a 0.00% expense ratio. A few caveats to note regarding FZROX are that it follows Fidelity’s in-house proprietary total stock market index and it is only available to Fidelity customers. It also has some limitations with portability - meaning transfers to other investment firms. But if you are a lifelong Fidelity customer this shouldn’t be a problem.
Charles Schwab Equities Alternatives
If you are invested with Charles Schwab, Schwab Total Stock Market Index Fund, also known as SWTSX is your best option. It has a low expense ratio of 0.03% which is very competitive to Vanguard’s VTSAX and is most appropriate for Schwab investors looking for a total stock market index option for their retirement accounts.
Bond Alternatives
As regards alternatives to VBTLX, I have two recommendations. The first bond recommendation is the Fidelity® U.S. Bond Index Fund also known as FXNAX. It tracks the Bloomberg Barclays U.S. Aggregate Bond Index which is composed of investment-grade government bonds, corporate bonds, and mortgage-backed securities. It holds approximately 8,430 bonds. The top issuers are the US Treasury or issuers of Mortgage Backed securities like Fannie Mae and Freddie Mac. It has an expense ratio of 0.025%. This means if you have $10,000 invested in Fidelity U.S. Bond Index Fund, you are essentially paying $2.50 for Fidelity to manage this fund for you.
The second bond recommendation is the Schwab U.S. Aggregate Bond Index Fund also known as SWAGX. It tracks the Bloomberg US Aggregate Bond Index. A broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, and mortgage-backed securities. Schwab U.S. Aggregate Bond Index Fund holds approximately 8,090 bonds. The top issuers are the US Treasury or issuers of Mortgage Backed securities like Fannie Mae and Freddie Mac. It has an expense ratio of 0.04%. This means if you have $10,000 invested in Schwab U.S. Aggregate Bond Index Fund, you are essentially paying $4.00 for Charles Schwab to manage this fund for you.
International Exposure
Another common question I get is what about international exposure. There’s a lot of talk about international companies like Samsung Electronics, Taiwanese Semiconductor Manufacturing Company (TSMC), or Tencent Holdings. By holding only VTSAX and VBTLX aren’t you missing out on all the gains from the international market? Actually not.
When you are buying a fund like VTSAX, which includes all publicly traded companies, you are tapping into the international market. Indirectly, but still connected.
Today many of the major US-based companies generate a good percentage of their sales and profit overseas. Just look at Apple. The biggest US company based on market capitalization. However, as of the second quarter of the fiscal year 2021, 67% of Apple’s total revenue was generated from outside the United States. At one point, there were more Chinese people purchasing Apple products than there were Americans.
On another note, where do you think all the parts that Apple uses for its products come from? They come from the rest of the world. Display from Japan. Ram from Korea. Battery from China. When we invest in VTSAX we are investing in Apple. And thus in essence investing in all the companies that supply Apple. The world is a lot more integrated today than ever.
With that said, if you still like some additional exposure directly to international companies, I recommend the Vanguard Total International Stock Index, the VTIAX as your fund of choice. It has an expense ratio of 0.11% and represents close to 8,000 (7,991) non-US international companies.
That’s it guys. The world’s simplest portfolio. Two index mutual funds and a checking account. If you would like to learn more from someone much more qualified to talk about this concept, please check out JL Collins' The Simple Path to Wealth. It was this book that really inspired me to simplify my investing approach and I haven’t looked back.
