My Case for a Simple, Low-Cost Investment Strategy

Back in 1993, while writing my book , I explored the countless asset allocation strategies available to investors. It struck me then that sometimes, “less is more.” I had a hunch that a simple, mainstream balanced fund—60% in U.S. stocks and 40% in U.S. bonds, all in a low-cost index format—could offer the same functional benefit as hiring a high-priced investment advisory firm.

A year earlier, in 1992, I put that idea into practice by forming just such a fund at Vanguard. Looking back over the quarter-century that followed, the results have been nothing short of an extraordinary success.

The Power of Keeping Costs Low

Let’s dig into the numbers from 1992 to 2016. The low-cost balanced index fund delivered an annual return of 8.0%. Its peer group—the average actively managed balanced mutual fund—returned just 6.3% per year. That 1.7 percentage point difference might not sound like much, but over 25 years, the power of compounding turned it into a massive gap. The index fund grew by 536%, while the average peer fund grew by 334%.

The secret sauce wasn’t complex trading or brilliant market timing. It was simply cost. The balanced index fund had an average expense ratio of just 0.14%, while its competitors charged an average of 1.34%. That cost advantage is the primary reason for its outperformance. Given that the fund’s returns moved in near-perfect lockstep with its peers (a 0.98 correlation), it’s reasonable to expect this pattern of outperformance to continue. For those just learning , understanding the impact of fees is one of the most important first steps.

The Trade-Off Between Growth and Stability

Now, could you have done better? Yes. An investor holding a low-cost S&P 500 Index fund during the same period would have earned a 9.3% annual return. But that higher return came with a much bumpier ride. The S&P 500 fund’s volatility was significantly higher (14.3%) compared to the balanced fund’s (8.9%).

When the market got rough, the balanced fund truly shined. During the dot-com bust from 2000 to 2002, the S&P 500 plunged by 38%, but the 60/40 balanced fund only dropped by 14%. In the 2008 financial crisis, the S&P 500 fell 37%; the balanced fund fell just 22%.

For investors with a very long time horizon and nerves of steel, a 100% allocation to stocks will almost always be the better choice. But what if you have a shorter timeline? Or what if you know you’re the type of person who might panic and sell during a crash? For you, the hands-off, stay-the-course approach of a 60/40 balanced fund is an option worth serious consideration. This is a foundational concept in .

Finding the Right Mix for You

The legendary investor Benjamin Graham long advised a baseline allocation of 50% stocks and 50% bonds. He suggested that investors could adjust this anywhere between a 75/25 and a 25/75 split, depending on their tolerance for risk. More stocks for those seeking greater wealth, and more bonds for those who value peace of mind.

I’m often associated with a similar rule of thumb: your age should be your bond percentage. A 30-year-old would have 30% in bonds and 70% in stocks, while a 70-year-old would have 70% in bonds. This is a great starting point for your thought process, but it was never meant to be a rigid rule. True wisdom in lies in knowing how to adapt such rules.

Flexibility is key. A young person just starting their career could reasonably invest 100% of their savings in equities. Conversely, someone who just turned 100 probably shouldn’t have 0% in stocks, especially when you consider the potential capital gains taxes from selling appreciated assets. Common sense should always guide your plan.

Shifting Focus from Accumulation to Income

As we get older, we rely less on our ability to earn a paycheck (human capital) and more on our accumulated savings (investment capital). When you retire, the daily fluctuations in your portfolio’s market value become less important. What really matters is the steady stream of income you need to live on—the dividend checks from your funds and your monthly Social Security payments.

What we’re really seeking is retirement income that is steady and, ideally, grows with inflation. Social Security is designed for this perfectly. A balanced mutual fund can be a powerful supplement. About half of a balanced portfolio's income comes from bond interest, and the other half from stock dividends. It’s a powerful combination that helps you . Since 1926, dividends on the S&P 500 have increased in all but three years, providing a remarkably reliable, growing stream of cash flow.

With current yields on stocks and bonds near historic lows, relying on interest and dividends alone may not be enough. This is where a total return approach comes in. You can generate a steady monthly check by combining the fund’s income with regular, planned withdrawals from your capital. The goal is to create sustainable that support you for decades.

The Global Investing Question

In recent years, the classic two-fund model (U.S. stocks and U.S. bonds) has often been replaced by a three-fund model that adds a significant allocation to non-U.S. stocks. The argument is that a global portfolio is more diversified.

I’ve historically argued that most Americans don’t need to hold non-U.S. stocks. We earn, spend, and save in dollars, so why introduce currency risk? Furthermore, about half of the revenue and profits of major U.S. corporations already come from overseas. Since 1993, this U.S.-centric advice has worked out well, with the S&P 500 significantly outperforming a broad international index (9.4% vs. 5.1% annually).

That said, markets change. It’s possible that the long period of U.S. outperformance has led to more attractive valuations abroad. There’s no crystal ball, so you’ll have to weigh the probabilities and make your own judgment.

Modern "Set It and Forget It" Options

The 60/40 balanced fund was designed for simplicity, but that specific ratio isn’t perfect for everyone. This led to the creation of funds with different fixed allocations, like Vanguard’s “LifeStrategy” series, which offer mixes ranging from 80% stocks down to 20% stocks.

More recently, Target-Date Funds (TDFs) have exploded in popularity. These funds automatically become more conservative as they approach their target date, which is usually the year you plan to retire. All you do is pick the fund closest to your retirement year, and the fund handles the rest.

If you opt for a TDF, be sure to look under the hood. Some are built with low-cost index funds, while others use more expensive, actively managed funds. An actively managed TDF might have an expense ratio of 0.70%, while an index-based one could be as low as 0.13%. I firmly believe the low-cost, index-based TDFs are your best option for building a through your investments.

Don't Forget Your Biggest Asset: Social Security

No matter your strategy, you must account for Social Security. For the 93% of retired Americans who collect it, Social Security is a major source of income. When determining your asset allocation, you should think of your future Social Security benefits as a bond-like asset.

Here’s an example. Let’s say a 62-year-old has a $1 million portfolio and aims for a 50/50 stock/bond split. They might put $500,000 in stocks and $500,000 in bonds. But let’s also say the present value of their future Social Security payments is about $200,000. When we add that to their portfolio, their total assets are now $1.2 million. The bond-like portion is actually $700,000 ($500k in funds + $200k in Social Security), making their real allocation 58% bonds and 42% stocks—far more conservative than they intended. To achieve a true 50/50 split, they would need to allocate $600,000 to stocks and only $400,000 to bond funds. This is a critical detail in understanding for retirement.

A Final Word on Simplicity

With all the sophisticated options available today, the simple elegance of a 60/40 balanced index fund is often overlooked. But in 2017, Ben Carlson, author of , highlighted this very concept. He compared a simple "Bogle Model" (60% stocks, 40% bonds, all in low-cost index funds) to the performance of over 800 complex university endowments.

Over the 3, 5, and 10-year periods ending in 2016, the simple model consistently beat the average endowment. For the full decade, it even outpaced the top-performing endowments. Carlson concluded that this wasn’t about active vs. passive management. It was about simple vs. complex and high-probability vs. low-probability portfolios. When it comes to , sometimes the simplest approach really does win.