Sunday, July 26, 1998

Gird yourselves, Couch Potato Investors, were taking Sloth to the Next Level!

The Couch Potato investor, you will recall, divides his money into two equal piles and puts half of it in a broad index fund for common stocks and half into a broad index fund for fixed income investments. Once a year, if so moved, the Couch Potato takes out his calculator, divides the total portfolio by the number "2" and performs the Herculean task of "rebalancing" the portfolio. This is done to prove that he pays some attention to his investments and to protect the integrity of the basic idea.

As demonstrated in this column for a number of years, the Couch Potato Investor reveals true brilliance by resisting all pressure to think and worry about whats happening with his money. Instead, the Couch Potato maintains a posture of sublime indifference.

Which brings us to attaining The Next Level.

Suppose you made a commitment, once, sold your calculator in a garage sale, and forgot about the whole anxiety provoking business? Suppose you didnt rebalance. Not once. Suppose you put your passive chips down and letem ride? Suppose you became The Comatose Couch Potato?

How would you have done?

To find the answer, I used Morningstars Portfolio Developer software and assumed 50/50 investments in the Vanguard Index 500 fund and Vanguard F/I GNMA fund. While the second fund isnt a true index fund, it broadly reflects index performance and has the benefit of a long history. If we used the Vanguard Intermediate Government fund (which I would prefer) wed be limited by its history of seven years.

Starting with a $10,000 investment in each fund, I simply let them grow without adjustments or rebalancing. As you would expect, longer the investment period, the larger equities loom in the comatose portfolio: starting at 50/50, the portfolio became 54.4 percent equities after a year, growing to 71.6 percent after 15 years. Since new commitments to mutual funds by the investing public have been running better than 75 percent equity, 25 percent fixed income, it could be said that we were just "going with the flow."

Did we get in trouble?

No. Indeed, it seems to be a pretty smart strategy: be cosmically indecisive once, say "split the difference" and put half the money in equities, half in bonds, and run away as fast as possible. The comparative figures show that being comatose would have better than the average domestic balanced fund in 4 of 6 periods and better than the average of all equity funds in 3 of 6 periods. In my view this says a whole lot for sloth. (See figures in table below)

The Comatose Couch Potato vs. Balanced and Equity Funds

Period Portfolio Value Percent Equities at End Return Avg. Domestic Balanced return Avg. all Equity Funds return
Year to date $22,099 53.2% 9.68% 8.58% 9.39%
1 year 23,895 54.4 17.54 17.08 14.97
3 years 34,633 63.6 18.23 17.27 18.11
5 years 42,098 66.7 14.34 13.41 15.49
10 years 77,648 69.5 12.52 12.71 14.00
15 years 146,198 71.6 11.77 12.92 12.94

Source: Morningstar Portfolio Developer, June 30, 1998 data (return figures over 1 year are annualized rates of return, all figures based on initial investments of $10,000 in each fund.)

Now lets see how sloth and indecision performed compared to asset allocation mutual funds— the funds where managers have the freedom to move money to wherever they think theyll get the highest returns at the least risk. As you can see from the table below, our Next Level Couch Potato is in the top half of the asset allocators, the guys that earn the Big Bucks for knowing the future of places like India, Turkey, and Eastern Europe. Basically, it appears that the Comatose Couch Potato beats active management somewhere between 6 times out of 10 and 2 times out of 3.

The Benefits of Indecision

Period Next Level Couch Potato (Percentile) 20th Percentile Asset Allocation 50th Percentile Asset Allocation
15 years 11.77% (20th) 11.46% 11.04%
10 12.52 (40th) 13.61 12.28
5 14.34 (35th) 15.59 13.79
3 18.23 (38th) 19.71 16.70
1 17.54 (44th) 21.40 16.90
Year to date 9.68 (41st) 12.00 9.08

Source: Morningstar Portfolio Developer, data for period ending June 30, 1998. A 20th percentile performance has done better than 80 percent of all funds; a 50th percentile performance has done better than 50 percent of all funds.

Message?

The most important thing isnt what we know or learn, it is that we commit. Even if we are indecisive about where the money goes and "split the difference", spreading our money among alternatives, odds are we will do better than not making a commitment or making a commitment and trying to predict the future.

Be there now.