Couch Potato Cookbook
There are a few things Couch Potato investors need to know. The word “few” is important because the basic goal of Couch Potato investing is to make it quick, simple, cheap and effective. This is very different from slow, complicated, expensive, and ineffective. As a consequence, Couch Potato investment returns should be better than the returns earned by the millions of people who rely on the complexities of typical Wall Street investing.
Does this mean you’ll never lose money as a Couch Potato investor? Sorry, no.
Couch Potato investors, however, tend to lose less in a down market and make more in an up market. While the percentile rankings for trailing performance vary from month to month, Couch Potato investors are almost always in the top 50 percent and are frequently in the top 25 percent of portfolio categories called “Moderate Allocation” or “World Allocation” by Morningstar. You can check this for yourself by writing down the trailing return of a Couch Potato Building Block portfolio and then comparing it against the “Category Average” figures on the Morningstar website.
This isn’t a miracle. This is an idea that keeps your investing simple, flexible, and very inexpensive. Since all of the portfolios contain equal amounts invested in each component, you determine the amount to invest in each fund very simply—divide the amount you want to invest by the number of funds you intend to have in your portfolio. That would be a number ranging from 2 (for the original Couch Potato) to 10 (for the Ten Speed Portfolio).
- 1/2—Vanguard Inflation-Protected Securities (VIPSX)
- 1/2—Vanguard Total Stock Market Index (VTSMX)
- 1/3—Vanguard Inflation-Protected Securities (VIPSX)
- 1/3—Vanguard Total Stock Market Index (VTSMX)
- 1/3—Vanguard Total Intl Stock Index (VGTSX)
- 1/4—Vanguard Inflation-Protected Securities (VIPSX)
- 1/4—Vanguard Total Stock Market Index (VTSMX)
- 1/4—Vanguard Total Intl Stock Index (VGTSX)
- 1/4—SPDR Lehman International Treasury Index (BWX) *
- 1/5—Vanguard Inflation-Protected Securities (VIPSX)
- 1/5—Vanguard Total Stock Market Index (VTSMX)
- 1/5—Vanguard Total Intl Stock Index (VGTSX)
- 1/5—SPDR Lehman International Treasury Index (BWX) *
- 1/5—Vanguard REIT Index (VGSIX)
Six Ways from Sunday
- 1/6—Vanguard Inflation-Protected Securities (VIPSX)
- 1/6—Vanguard Total Stock Market Index (VTSMX)
- 1/6—Vanguard Total Intl Stock Index (VGTSX)
- 1/6—SPDR Lehman International Treasury Index (BWX) *
- 1/6—Vanguard REIT Index (VGSIX)
- 1/6—Vanguard Energy (VGENX)
- 1/7—Vanguard Inflation-Protected Securities (VIPSX)
- 1/7—Vanguard Total Stock Market Index (VTSMX)
- 1/7—Vanguard Total Intl Stock Index (VGTSX)
- 1/7—SPDR Lehman International Treasury Index (BWX) *
- 1/7—Vanguard REIT Index (VGSIX)
- 1/7—Vanguard Energy (VGENX)
- 1/7—Vanguard Value Index (VIVAX)
Seven Value 2
- 1/8—Vanguard Inflation-Protected Securities (VIPSX)
- 1/8—Vanguard Total Stock Market Index (VTSMX)
- 1/8—Vanguard Total Intl Stock Index (VGTSX)
- 1/8—SPDR Lehman International Treasury Index (BWX) *
- 1/8—Vanguard REIT Index (VGSIX)
- 1/8—Vanguard Energy (VGENX)
- 1/8—Vanguard Value Index (VIVAX)
- 1/8—Vanguard Small Cap Value Index (VISVX)
- 1/9—Vanguard Inflation-Protected Securities (VIPSX)
- 1/9—Vanguard Total Stock Market Index (VTSMX)
- 1/9—Vanguard Total Intl Stock Index (VGTSX)
- 1/9—SPDR Lehman International Treasury Index (BWX) *
- 1/9—Vanguard REIT Index (VGSIX)
- 1/9—Vanguard Energy (VGENX)
- 1/9—Vanguard Value Index (VIVAX)
- 1/9—Vanguard Small Cap Value Index (VISVX)
- 1/9—Vanguard Emerging Markets Stock (VEIEX)
- 1/10—Vanguard Inflation-Protected Securities (VIPSX)
- 1/10—Vanguard Total Stock Market Index (VTSMX)
- 1/10—Vanguard Total Intl Stock Index (VGTSX)
- 1/10—SPDR Lehman International Treasury Index (BWX) *
- 1/10—Vanguard REIT Index (VGSIX)
- 1/10—Vanguard Energy (VGENX)
- 1/10—Vanguard Value Index (VIVAX)
- 1/10—Vanguard Small Cap Value Index (VISVX)
- 1/10—Vanguard Emerging Markets Stock (VEIEX)
- 1/10—Vanguard International Value (VTRIX)
* - When the Couch Potato Building Block portfolios were introduced there was no index fund for international bonds. So a low cost managed international bond fund was used--- American Century International Bond fund, ticker BEGBX. Since late 2007, however, it has been possible to buy shares of an ETF that invests in a portfolio of foreign treasury bonds, the SPDR Lehman International Treasury Index (ticker: BWX). For more information see this column: A Better Building Block
We used the American Century Fund in our trailing return calculations for quite a few years because we want to be able to report trailing returns for at least 5 years. And now we can do it using an ETF index fund, BWX. Significantly, using the exchange traded index fund improved results for all of the Building Block portfolios using an international bond fund--- over the 3 and 5 year periods ending October 31, 2012, for instance, BWX provided annualized returns of 3.59 percent and 4.96 percent, respectively. This was well ahead of the 2.47 percent and 4.00 percent returns earned by the managed fund.
You can learn the entire history of these portfolios by going to the Couch Potato column collection. Reading this will keep you busy for a while. There are 60+ columns in the collection, starting with this one from 1991 about “Exactly How to Be a Couch Potato Portfolio Manager.”
Exactly how to be a better portfolios manager
Or where Scott introduced the Margarita Portfolio in honor of the other Buffett, the one named Jimmy.
The Margarita Portfolio
How about Scott’s introduction to the Couch Potato Building Blocks idea:
Introducing the couch potato building blocks
Where do I belong?
How do you determine the best number of funds to have in your portfolio? There are two simple ways. First, consider the size of your portfolio. If it’s less than $30,000 you probably shouldn’t be in anything with more than 6 building blocks. Second, you decide how much risk you want by deciding whether you want a 50, 60, or 67 percent commitment to equities vs. fixed income. The basic Couch Potato and Four Square portfolios have a 50 percent equity commitment, the Five Fold portfolio has a 60 percent equity commitment, and the Margarita and Six Ways from Sunday portfolios have a 67 percent equity commitment.
After that, each increase in the number of building blocks increases your equity commitment, reaching a maximum of 80 percent with the Ten Speed. That’s pretty aggressive.
Can you make substitutions?
Of course, as long as they make sense. We’re not perfectionists or theorists here, we’re pragmatists. We’re interested in doing what works. Here are some examples.
- Example 1. If you read the prospectus for Vanguard Energy fund you’ll find that it may be inexpensive, but it isn’t an index fund. I used it in the original Couch Potato Building Blocks because it was a reasonable thing to do. If you want to be an index purist, however, you can easily substitute an ETF like the Energy Select SPDR (ticker: XLE) or the Vanguard Energy ETF (ticker: VDE).
- Example 2. As pointed out earlier, when I introduced the Couch Potato Building Blocks no index fund for foreign bonds existed and most of the managed funds did substantial currency hedging. So, with reluctance, I used the American Century International Bond fund. Today, however, there are foreign bond index funds. Click Here to read the column I wrote about changing to one.
- Example 3. Vanguard has a REIT index fund that it also offers as an ETF, Vanguard REIT Index (ticker:VNQ). There are, however, many other REIT index funds. It would be very reasonable, for instance, to substitute the NAREIT residential REIT index ETF (ticker: REZ) for the broader Vanguard fund. This would get you a concentration of apartment REITS that are likely to benefit from a long-term shift back to renting from owning.
- Example 4. You don’t have to live at Vanguard or only use Vanguard funds. Many investors already have accounts at Fidelity and don’t want to move. Today, Fidelity offers a small number of very inexpensive index funds for major asset classes. You can fill in other classes with ETF purchases. Similarly, there are thousands of Federal employees who would like to be Couch Potatoes in the Federal Thrift Savings plan. Click here to read a column explaining how to do it.
- Example 5. Other substitutions are also possible. There is now a category of funds known as “fundamental” index funds that assemble their funds by different rules than conventional index funds. They are more expensive than conventional index funds but evidence suggests they will perform better because they capture more of the Fama/French value factor. Using the fundamental index EFTs, for instance, you could keep your portfolio to 6 or 7 building blocks and still capture the value factor. Click here to read about Rob Arnott’s research.
- Example 6. Index fund offerings continue to evolve. This is particularly true in the intensely competitive exchange traded funds arena. Brokerage commissions once made ETF portfolios impractical for the small investor. Since early 2010, however, it has become possible to build basic ETF portfolios without paying commissions. Read about this here and here. It is now possible to build one of the basic Couch Potato portfolios for less than 1/10 of 1 percent in annual expenses, entirely commission free. That gives Couch Potato investors a big head start over managed mutual funds, wrap accounts, and other financial products that cost 2 to 3 percentage points a year.
The basic idea is to be flexible, have fun and do it yourself. Put it this way: the Couch Potato Building Block Portfolios should be treated more like Italian cooking than French cooking.
But suppose I hate to cook? Then what do I do?
You’ve got two good choices. First, Couch Potato investing is so simple and consumes so little time that you really shouldn’t get worked up about it and just do it. Second, you have an alternative here at AssetBuilder. We build index fund portfolios with special attention to risk. We use index funds that are not available to retail investors and we construct our portfolios with a lot more attention to how the ingredients are mixed than picking a number from 2 to 10.
Will I benefit from having an AssetBuilder portfolio?
Long term, we believe you will. We know this because we regularly compare the returns of Couch Potato Building Block portfolios with their comparable AssetBuilder portfolio as determined by risk level. In other words, we compare the returns of portfolios with very similar standard deviations. While the margin of benefit varies, it is generally positive and can mean a return advantage, over five years, of 2 percent or more. You can check this for yourself by using our monthly update of performance and standard deviation for both portfolios Couch Potato and AssetBuilder.
All this would be meaningless if the Couch Potato Building Block portfolios routinely provided below average performance. But, as noted earlier, the record shows that Couch Potato investing has a very high probability of providing a higher return than 60 to 75 percent of all managed funds—and still more if you are paying significant fees for managing your portfolio of funds.
Is Couch Potato investing unique? Not at all. It is a practical way for do-it-yourself investors to avoid the risk Wall Street never talks about, fee risk. But it is part of a larger movement known as “lazy portfolios.” These are index fund portfolios that are low-cost and easy to manage offered by dozens of respected investors. As a group, these portfolios beat managed portfolios, as shown here in 2011 and here in 2012.