Simple doesn’t mean getting rich overnight.
Do you feel like investing is too complicated? Do you feel like you need a financial advisor to guide your way?
A portfolio built on two index funds can provide the simplest way to invest in your future. Author J.L. Collins wrote the book The Simple Path to Wealth to document the straightforward approach to investing for his daughter. His system is simple, and if you haven’t read the book, you should.
Index funds provide diversity that you cannot easily achieve when buying individual stocks. The two funds we will discuss today maximize diversity and minimize expense. The best part is that you can drive this two-fund strategy independently without the cost of a financial advisor.
VTSAX — Vanguard Total Stock Market Index Fund
VTSAX or its ETF alternate (VTI) contains 4,112 stocks in the fund. Instead of buying one share of a single stock, you purchase a small piece of many companies with each share of the fund.
The fund invests in more companies than the S&P 500, but the overall performance is relatively close to the index. This happens because the largest companies in the S&P 500 and the largest companies in VTSAX are the same. They impact performance the most when they move (up or down).
The expense ratio for VTSAX is 0.04%. That is amazingly low. Most mutual funds of this type have expense ratios closer to 0.80%. It’s important to know that the expense of investing, including fund and advisor fees, deteriorates your returns.
Vanguard investors are the owners, and instead of returning profits to shareholders, the company shares profits with investors. Since there are no public shareholders to return earnings to, the fees are low.
Fees on a $1 million investment are just $400 per year. For some perspective, I have a friend currently paying 2.5% to a financial advisor on top of the underlying fund fees within his portfolio. VTSAX is a remarkably low-cost investment vehicle.
VTSAX includes US-based companies. Some would argue that you should have international companies represented. J.L. Collins addressed this concern in his book, stating that many of the companies in VTSAX are global. If you need an international component, you could also add VTIAX (Vanguard Total International Stock Index Fund). Large multinational companies exist in both funds, so you will have some overlap if you choose this approach.
The dividend yield for VTSAX is 1.44% as of June 2, 2022. If you base your retirement on the 4% rule, about a third of your income could come from dividends.
VBTLX — Vanguard Total Bond Market Index Fund
VBTLX or its ETF alternate BND invests in 10,176 bonds with an expense ratio of 0.05%. This fund invests in US investment-grade bonds with expenses well below the competitor average of 0.59%.
Bonds may not play a significant role in your portfolio today. As you build for the future, the cash you invest helps smooth the bumps from the market. The money you add to your investment plays a similar role to bonds.
Bonds may play a more prominent role when you get closer to retirement. William Bengen used a 50% stocks / 50% bonds mix to determine the worst-case withdrawal rate (4%) in 1994. The Trinity Study expanded on Bengen’s research and updated portfolio success rates based on various stocks and bonds ratios.
The percentage of bonds in your portfolio should be relative to your risk tolerance. The lower the portion of bonds, the more risk you take.
In the book Quit Like a Millionaire: No Gimmicks, Luck, or Trust Fund Required, author Kristy Shen discusses the role of bonds in her portfolio. Her risk tolerance is lower than J.L. Collins’s, and she chose a 50/50 split between stocks and bonds. Ms. Shen’s book is a good read, and she provides a comprehensive explanation for her strategy.
Summary
Investing for your future doesn’t have to be complicated, although most of the financial industry like investors to believe it’s too challenging to go it alone.
You can build an extremely diverse portfolio with only two funds — VTSAX for stocks and VBTLX for bonds. These funds have meager fees and have components that represent the broad market. The funds are not at risk of going to zero, like an individual stock or bond.
If your goal is to create wealth the easiest way possible, VTSAX and VBTLX are the perfect vehicles for your journey.
