If you're not sure how to invest, it's as easy as picking two funds.

By Paul A. Merriman

Get peace of mind, plus a piece of the action

Young investors of any age can do just fine with only two funds for their entire life.

This idea isn't new or exclusive to me. And yet the ultrasimple plan I'll outline here is more sophisticated than many others you'll find. It's based on sound research, nearly 100 years of history and a heathy serving of common sense. As a bonus, it's easy to understand and easy to implement.

This is the ninth and final installment in a series of articles that I have been calling boot camp for investors 2024.

-- The first article showed that over the past 96 years, investors have been far better off in stocks than in bonds.

-- In the second article, we saw how even small changes can mean millions more dollars in retirement.

-- In the third, we showed historical returns and risks of various combinations of equity asset classes.

-- In article four, we discussed how to use fixed-income funds to limit your investment risk.

-- Then, in installment five, we focused on the best ways to accumulate and invest the money for retirement.

-- Article six showed how to cope when you need to retire with just enough to meet your needs.

-- In article seven, I showed the (potentially enormous) benefits of saving more than you think you'll need and of diversifying your equities beyond the S&P 500 SPX.

-- And article eight introduced a powerful online tool to backtest a variety of combinations to see how they would have performed.

Like any good boot camp, this series has put serious investors through their paces in many ways.

But if you'd rather accomplish something easily instead of working up a sweat, then today - you are in exactly the right place.

Let's start with the most important things you need as a lifetime investor.

-- You want your money to grow over many years, probably decades.

-- You want peace of mind knowing someone (with lots of qualifications and no hidden agenda) is looking out for your interests.

-- You want to keep your costs as low as you can.

-- You want your portfolio to become more conservative as you age.

-- You certainly don't want to run out of money.

-- You want to manage all this with a minimum of time and attention.

That's a pretty tall order. And you can accomplish all of it with just two funds.

The portfolio I call Two Funds For Life starts with a base fund that will meet all those "wants" in one entity: a target-date retirement fund.

If you have a job and a 401(k) or similar retirement plan, you almost certainly have access to such a fund. And it's likely you can find one with a "target date" that approximates the year you want to retire.

Most target-date funds are offered in five-year increments to accommodate investors of all ages. For example, if you hope to retire in about 25 years, you can choose Vanguard's Target Retirement 2050 Fund VFIFX.

Target-date funds are invested in both stocks and bonds, a mix that's designed to provide some diversification and to gradually increase its percentage of bond funds as the target date approaches.

The second component of Two Funds For Life is a booster fund, entirely invested in stocks, with the purpose of giving you the potential for additional long-term growth.

This booster fund invests in small-cap value stocks: smaller companies (with lots of room to grow) that you can buy at bargain-basement prices. Of the major U.S. equity asset classes, this one has the strongest long-term record of producing high returns.

For more on small-cap value stocks, check out this list of excellent resources.

Why have two funds?

For a super-simple retirement savings plan, you could stop with just a target-date fund. That would give you ample peace of mind. But adding a small-cap value fund gives you something more: something that I like to call "a piece of the action." This "something" could easily increase your retirement holdings by 30% to 70%.

With Two Funds For Life, the main question is how much of your portfolio to keep in the target-date fund and how much in the small-cap value fund.

This decision will depend on your age and how much additional risk you are willing to take in order to improve your returns.

For a simple and relatively conservative answer to stick with for the rest of your life, I find it easy to recommend leaving 90% of your assets in the target-date fund, with 10% in small-cap value.

That 10% will increase the portfolio volatility a little, but I doubt you would even notice it. And over the long term, it can make a huge difference in the amount you have when you retire.

How much difference? That's going to be different for every investor. But it can be very significant.

Chris Pedersen, our foundation's director of research and the founder of the Two Funds For Life strategy, calculated that holding 10% of a portfolio in small-cap value and the rest in a target-date fund for 25 years before retirement would boost the return of the portfolio by 0.5 percentage points, for a 5.1% increase compared with no small-cap value.

For those who start earlier, the increase would be larger, as shown in the following table. To arrive at the numbers, Chris used historical compound rates of return for small-cap value stocks and for a typical target-date fund.

The scenario is this: You invest $5,000 when you're 25, then add $5,000 a year after that until you're 64. Over 40 years, your investments total $200,000.

   Effect of shifting 10% of a portfolio from target-date fund to small-cap value, with annual rebalancing, ages 25-65 
   Percentage in target-date fund                                                                                       100            90 
   Percentage in small-cap value                                                                                        0              10 
   Portfolio value age 50                                                                                               $582,763       $631,870 
   Portfolio value age 65                                                                                               $2.31 million  $2.69 million 
   First year withdrawal at 4%                                                                                          $92,444        $107,404 
   First year withdrawal at 5%                                                                                          $115,555       $134,267 

Those numbers indicate a 16.2% boost in what you'd have at retirement, purely from reallocating 10% of your portfolio. And if you kept that 10% small-cap value allocation in retirement, you'd likely increase your return in those years by 1.3 percentage points, for a 13% boost from the target-date fund by itself.

With this extremely simple approach, you're likely to have more money to spend in retirement and more to leave when you're gone.

If you want to pursue Two Funds For Life, you will find a lot of excellent resources here, including a new video recorded by Chris.That page includes links to free copies of two books that will be helpful: "We're Talking Millions! 12 Simple Ways to Supercharge Your Retirement," which Richard Buck and I wrote a few years ago, and "Two Funds For Life," written by Chris, is aimed at investors who want to roll up their sleeves and look under the hood at the details of this strategy.

And with that, you've made it to the formal end of investor boot camp 2024. Congratulations!

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We're Talking Millions! 12 Simple Ways to Supercharge Your Retirement.

-Paul A. Merriman

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09-21-24 0958ET

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