As the late Abby Hoffman once said of Worcester Massachusetts, the year 2005 was "best viewed from the rearview mirror of a rapidly moving car."

Not that it was terrible year.

We've had worse and the memories are recent. No, it was just a sub-par year. While the long term return on large common stocks has been 10.4 percent, the Standard and Poor's 500 Index returned less than half that in 2005. Similarly, while the long term return on intermediate government bonds has been 5.4 percent, the U.S. bond market returned less than half that in 2005. Basically, 2005 was a bum year for stay-at-home investors. This includes willfully slothful Couch Potato investors, at least the ones who were only willing to divide by "2" with the aid of an electronic calculator.

The Original Couch Potato portfolio, which I've been writing about for 14 years, returned only 3.65 percent. Large cap stocks continued to under perform small and mid cap stocks. And a year of rising interest rates dulled the bond market. The Original Couch Potato is one half Vanguard 500 Index fund and one half Vanguard Total Bond Market Index fund.

The newer Crispy Couch Potato portfolio, which uses the Vanguard Total Stock Market Index and the Vanguard Inflation Protected Securities fund in a 50/50 mixture, did somewhat better. It returned 4.22 percent for the year.

But if you were willing to divide your money by three instead of two, the Margarita portfolio (one-third each Vanguard Total Market, Vanguard Total International Stock, and Vanguard Inflation Protected Securities) returned a very nice 8.01 percent. The 15.6 percent return provided by international stocks saved the year.

Further diversification (and dividing by bigger numbers) brought mixed results. While Vanguard REIT index fund and Vanguard Energy returned 11.9 and 44.6 percent, respectively, the American Century International Bond fund lost 8.2 percent as the dollar came out of its funk and blasted ahead of the Euro.

As a consequence, the Four Square portfolio returned only 3.96 percent when Vanguard Total Market, Vanguard Total International Stocks, Vanguard Inflation Protected Securities, and American Century International Bond were mixed in equal proportions.

When Vanguard REIT index fund was added to create the Five Fold portfolio, the return rose to 5.55 percent, buoyed by the 11.9 percent return of the reits.

Finally, when Vanguard Energy fund was added to create the Six Ways portfolio, the 44.6 percent return of the energy fund took the portfolio return up to a handsome 12.06 percent.  (See table below.)

 

The Couch Potato Building Block Portfolios

The building block portfolios are constructed to maintain the equity/fixed income mix of a traditional balanced portfolio but increase the asset class diversification in even steps from two assets classes to six. Funds marked with an asterisk may be replaced with ETF funds. The percentile rank figure is for the funds category. This indicates that 5 of the 8 funds did better than at least 50 percent of their category competitors.

Ticker Fund Name

Total Return2005

% tilerank

Portfolio

12 Mos.Portfolio Return

AllocationStocks/Bonds

VFINX

Vanguard 500 Index*

4.8

59




VBMFX

Vanguard Total Bond Market*

2.5

16

Original Couch Potato

3.65

50/50

VTSMX

Vanguard Total Market*

5.84

36




VIPSX

Vanguard Inf. Protected Securities*

2.6

16

Crispy Couch Potato

4.22

50/50

VGTSX

Vanguard Total Int. Stock Market*

15.6

32

Margarita

8.01

67/33

BEGBX

American Century Int. Bond

(8.20)

76

Four Square

3.96

50/50

VGSIX

Vanguard REIT*

11.9

57

Five Fold

5.55

60/40

VGENX

Vanguard Energy*

44.6

45

Six Ways from Sunday

12.06

66/33

Source: http://www.morningstar.com/, 12/30/05 data

 

Significantly, every asset class represented here but one can be done with an index fund or an exchange traded fund--- except one. I put American Century International Bond fund, the one that lost 8.2 percent, into this mix because I was looking for alternatives to U.S. dollar denominated bonds.

Was it a mistake?

Long term, probably not. But the idea may be better than the fund. Then, and now, I would rather use an unmanaged international bond index with a broader currency reach if one were available. BEGBX, by its construction, is over weighted in the euro which fell dramatically after three years of rising against the dollar. With new exchange traded funds being registered every month, I would not be surprised if an international bond index became available sometime in 2006.

Are there any messages here?

Yes. Diversification pays. The more diversified portfolios did better than the basic two-fund Couch Potato portfolios.

On the web:

Margarita investors can toast higher gains

Build a better portfolio, block by block (Sunday, March 20, 2005)