A modified three-step three-dimensional (3-D) locally 1-D finite-difference time-domain (LOD-FDTD) method with reduction of numerical dispersion is introduced by virtue of parameter optimisation. Both theoretical and numerical studies of the unconditional stability of this proposed method are also presented. The numerical dispersion behaviour is investigated by comparison with the original LOD-FDTD method. The reduction of numerical dispersion error and the improved numerical accuracy can be observed from the numerical phase velocity computations under various time steps, spatial resolutions and frequencies. Numerical examples are included to illustrate the validity and improved accuracy of this proposed method.