Three fund portfolios for taxable accounts

The Taylor Larimore three-fund portfolio is a portfolio design consisting of three “total” market index funds covering the US stock market, the international stock market, and the US taxable investment grade bond market. However, investors with large taxable accounts and falling in high tax brackets may find that tax-exempt bonds provide higher after-tax returns and would prefer to use an intermediate-term tax exempt bond fund for the portfolio bond allocation in the taxable account.

Investors were able to implement this portfolio beginning in 1997, when Vanguard introduced a total international index fund. The firm had introduced a total US stock market index fund in 1992, and an intermediate US tax-exempt bond fund in 1977. (Tax-exempt bond index funds have limited performance histories, so we are using Vanguard’s low-cost active fund in this analysis.)

The 2016 returns for the portfolio’s constituent Vanguard funds (investor class):

  • Vanguard Total Stock Market Index Fund: 12.53%
  • Vanguard Total International Stock Index Fund: 4.65%
  • Vanguard Intermediate Tax-Exempt Bond Fund: 0.08%

Below are four portfolios with allocations devoting 30% of the stock allocation to international stocks (click images to enlarge).

The table below provides 2016 returns for these portfolios. Note that returns for portfolios holding admiral shares would produce a return enhancement of approximately 0.10% and that a different weighting of international stocks would result in differing returns.

Year 80/20 60/40 40/60 20/80
2016 8.15% 6.13% 4.11% 2.10%

Historical returns

The following tables give return data for three-fund portfolios assuming investment in Vanguard investor share funds. Keep in mind that past returns are no guarantee of future returns, but the history reveals how each portfolio allocation has performed over both the 2000 – 2002 and 2008 bear markets and ensuing recoveries.

Note that lower cost admiral share portfolios can add approximately +0.10% annual compound return for each allocation.

Three-fund portfolio returns

Year 80/20 60/40 40/60 20/80
2016 8.15% 6.13% 4.11% 2.10%
2015 -0.31% 0.48% 1.27% 2.07%
2014 7.39% 7.36% 7.32% 7.29%
2013 21.97% 16.09% 10.21% 4.32%
2012 14.59% 12.37% 10.15% 7.92%
2011 -1.03% 1.63% 4.29% 6.96%
2010 12.67% 10.03% 7.40% 4.76%
2009 26.93% 22.75% 18.58% 14.40%
2008 -31.35% -23.55% -15.75% -7.94%
2007 7.49% 6.47% 5.46% 4.44%
2006 15.97% 13.08% 10.20% 7.31%
2005 7.53% 6.21% 4.89% 3.56%
2004 12.66% 10.30% 7.94% 5.59%
2003 28.13% 22.21% 16.29% 10.38%
2002 -13.77% -8.35% -2.93% 2.49%
2001 -9.97% -6.21% -2.46% 1.30%
2000 -7.82% -3.55% 0.71% 4.98%
1999 20.41% 15.19% 9.96% 4.73%
1998 17.92% 14.88% 11.84% 8.80%
1997 18.59% 15.71% 12.83% 9.96%

Compound returns

The tables below give 3-year, 5-year, 10-year, 15-year, and 20-year compound returns and volatility statistics for each three-fund portfolio allocation.

80/20 allocation

3-year 5-year 10-year 15-year 20-year
CAGR 5.01% 10.11% 5.39% 6.64% 6.71%
STDev 4.68% 8.37% 15.99% 15.31% 14.90%

60/40 allocation

3-year 5-year 10-year 15-year 20-year
CAGR 4.61% 8.35% 5.25% 6.23% 6.36%
STDev 3.67% 6.00% 12.31% 11.62% 11.20%

40/60 allocation

3-year 5-year 10-year 15-year 20-year
CAGR 4.21% 6.55% 4.95% 5.66% 5.84%
STDev 3.03% 3.90% 8.78% 8.05% 7.62%

20/80 allocation

3-year 5-year 10-year 15-year 20-year
CAGR 3.79% 4.71% 4.49% 4.93% 5.18%
STDev 3.00% 2.78% 5.68% 4.89% 4.51%

Variance drain

A higher variance of returns results in a fund having a compound return lower than its average arithmetic return. Variance drain (arithmetic return minus compound return) measures the amount of return lost due to variance. The table below gives results over the 1997 to 2016 period.

Three-fund portfolios variance drain

Period 80/20 60/40 40/60 20/80
3yr variance drain -0.07% -0.04% -0.03% -0.03%
5yr variance drain -0.25% -0.13% -0.06% -0.03%
10yr variance drain -1.26% -0.72% -0.36% -0.14%
15yr variance drain -1.16% -0.65% -0.30% -0.11%
20yr variance drain -1.10% -0.61% -0.28% -0.09%

A brief note regarding tax efficiency

Taxable accounts are subject to annual taxation under existing tax regulations, which change over long holding periods. Reducing tax costs is an important consideration for taxable investors. Under current law, consider these points:

    • Long-term capital gains and qualified dividends are taxed at lower rates. In general, index funds tend to realize little or no capital gains distributions and usually provide high levels of qualified dividends.
    • Certain tax-exempt bond interest (from private activity bonds) is subject to taxation under the alternative minimum tax (AMT). Note that the Vanguard active tax-exempt bond funds are permitted to invest up to 20% of their portfolios in private-activity bonds. Currently index funds and exchange-traded funds linked to AMT-free bond indexes are available.

Addendum

Calculated returns data uses this three-fund portfolio for taxable accounts google drive spreadsheet. The spreadsheet contains returns data for an assortment of international stock allocations (20%,40%,50% of the equity allocation).

Allocation 80/20 70/30 60/40 40/60 20/80
20% international CAGR CAGR CAGR CAGR CAGR
3yr 5.77% 5.48% 5.19% 4.59% 3.98%
5yr 10.82% 9.86% 8.89% 6.92% 4.89%
10yr 5.86% 5.75% 5.60% 5.18% 4.60%
15yr 6.73% 6.53% 6.29% 5.70% 4.95%
20yr 6.97% 6.77% 6.54% 5.96% 5.24%
30% international
3yr 5.01% 4.81% 4.61% 4.21% 3.79%
5yr 10.11% 9.23% 8.35% 6.55% 4.71%
10yr 5.39% 5.34% 5.25% 4.95% 4.49%
15yr 6.64% 6.46% 6.23% 5.66% 4.93%
20yr 6.71% 6.55% 6.36% 5.84% 5.18%
40% international
3yr 4.23% 4.14% 4.04% 3.82% 3.60%
5yr 9.39% 8.60% 7.81% 6.19% 4.53%
10yr 4.91% 4.93% 4.90% 4.72% 4.37%
15yr 6.54% 6.37% 6.16% 5.62% 4.91%
20yr 6.45% 6.33% 6.16% 5.72% 5.12%
50% international
3yr 3.46% 3.46% 3.46% 3.44% 3.30%
5yr 8.66% 7.97% 7.27% 5.83% 4.34%
10yr 4.43% 4.51% 4.55% 4.48% 4.26%
15yr 6.44% 6.29% 6.09% 5.57% 4.90%
20yr 6.18% 6.10% 5.97% 5.59% 5.05%

 

About

Barry Barnitz, administrator of both the Bogleheads® wiki and of Financial Page, a Bogleheads® blog

Tagged with:
Posted in Market statistics, Portfolios
October 2017
M T W T F S S
« Sep    
 1
2345678
9101112131415
16171819202122
23242526272829
3031  
Categories
Archives
Follow Financial Page on WordPress.com
%d bloggers like this: