How is the Couch Potato Portfolio doing?

These inquiries come in from readers, as if asking after the health of a hospital patient. The answer is that the Couch Potato Portfolio has been ill. It remains an outpatient, however, while many other portfolios are in Intensive Care.

As of August 26th the Original 50/50 Couch Potato Portfolio was off nearly 6 percent year-to-date. The more aggressive Original 75/25 Couch Potato portfolio was off 11.30 percent year-to-date.

Measured from the end of 1999, the 50/50 Couch Potato was off a total of 6.6 percent while the 75/25 Couch Potato was off a painful 20.7 percent. Over the same period only a handful of fund categories did better.  

None of those are happy numbers. But it could be a whole lot worse. If there is a major lesson from this bear market it is this: simple diversification works.

If you had heroic expectations for the Couch Potato, let's get our goals straight right now. The basic idea behind the Couch Potato portfolio is to have a very simple investment plan that achieves superior (but not supernatural) performance by virtue of its low expenses rather than its brilliant management.

We know from 30 years of experience and research that the majority of professional managers can't beat the market and that the cost of managing the money--- including buying all those nifty mega-houses in Jackson Hole, Aspen, etc.--- is high enough to make the Couch Potato portfolio look pretty good.

Basically, what I've come to expect is that the Couch Potato Portfolio will rank somewhere in the second quartile. That means it's almost never in the top 25 percent. But it's almost never in the bottom 50 percent, either. It is possible, with effort and expense, to do better--- but the odds are nearly 4 to 1 against it.

Is this a portfolio that never changes?

No. My intention is to keep the basic principles--- simplicity, passivity, and low expenses--- but to adapt as new tools come along.

When I started this exercise eleven years ago, there were only a handful of index funds with track records of five years or more . Back then, the S&P 500 stocks accounted for about 85 percent of all domestic market value. The index was a reasonable approximation for the market, but it wasn't the entire market. The increase in the number of equities over the last 10 years has made it less accurate as a market proxy.

Today, the S&P 500 index accounts for about 74 percent   of all domestic market value. It's now possible, however, to buy an index fund that represents the entire market. That's why I started showing results for a "New!" and "Improved!" Couch Potato portfolio using the Vanguard Total Stock Market Index . If this is too financial for you, think of it as a KFC choice. First there was Original Kentucky Fried Chicken. Now we have "Extra Crispy."

The Vanguard Total Bond Market Index was the best I could do for an intermediate bond index in 1991. While the index continues to include all long-term bonds, the shortening maturities of mortgage securities and Treasuries have worked to bring the fund closer to a true intermediate bond fund.   Here's how the Original and Extra Crispy Couch Potato Portfolios compare so far this year

  
Checking The Couch Potato Portfolios
This chart shows the year-to-date figures for the Original and Extra Crispy Couch Potato Portfolios.
Portfolio 50/50 75/25
Original (V500) -5.97 percent -11.30 percent
Extra Crispy (Total Market) -5.50 -10.58
Source: http://www.morningstar.com/, August 26 data
  

As you can see, Extra Crispy has improved performance a bit. In theory, enlarging the pool of stocks to include small cap and mid cap should give a modest boost to long-term performance. The operative word here is "modest."

Does the future hold more change?

I think so. When the Treasury started offering inflation-protected securities in 1997 they opened a new world of opportunity. These securities offer a real return of 2 to 3 percent a year plus the rate of inflation--- a return that makes them competitive with conventional bonds. If Vanguard Inflation Protected Securities fund had been used in the "Extra Crispy" 50/50 portfolio this year, its return would have been a loss of only 1.56 percent instead of a loss of 5.5 percent.

My bet is a lot of people out there would like an easy way to lose only 1.56 percent in a bad year--- and make a bunch in a good year.

It doesn't sound bad, either:   Inflation Protected! Extra Crispy Couch Potato Portfolio!