As a 31 year old that is married with a family, I would like to adjust the couch potato portfolio to better match the 'recommended' asset allocation for someone of my age and risk tolerance. I am looking to invest in a portfolio that is 22% large cap, 27% small cap, 22% foreign stock, 21% fixed income and 8% cash. These percentages were created using the Smart Money One Asset Allocation tool on their website. These could obviously vary for each individual.
My approach is to invest in 100% index funds and invest the proportional amount of money from my portfolio to equal the recommended asset allocation percentages above, rather than a straight 50/50 couch potato index investment. Would this approach outperform the straight couch potato portfolio based on past performance? And, if so what index funds would you recommend using for each asset group? I am a big believer in Vanguards low cost approach and am considering using all Vanguard Index funds.
---S.G., by e-mail
A. The performance of your suggested portfolio relative to the basic Couch Potato would depend on the length of the time period selected. You are, however, taking a major step away from Couch Potato investing. So let's review the idea:
The Couch Potato portfolio was created to do several things. First, it was created to be "actionable." The simplest version, the 50/50, is close to ideal. Put half your money in a major stock index fund. Put the other half in a major bond index fund.
That's it. You're done. No optimizing. No slippery efficient frontier assumptions. No lengthy discussion of the rising correlation between domestic and foreign stocks.
In two steps you've minimized costs, reduced risks, and eliminated a good deal of pointless rumination.
We started with the Vanguard Index 500 fund because it was the first, largest, and least expensive of the index funds. Today, as mentioned in a number of columns, I'd look for a fund that covers the entire domestic stock market. Candidates for that would be any of the broad index funds. Examples are: the Vanguard Total Stock Index fund, Fidelity Spartan Total Stock Index, Schwab Total Stock Market Index fund, and T. Rowe Price Total Equity Market Fund. These funds emulate the performance of the Wilshire 5000 Index, the broadest index of the domestic stock market. By using the broad index, you'll accomplish one of your goals, which is to include small cap stocks in your portfolio.
Second, some of the distinctions between stock groups are a bit artificial. For instance, is Honda a Japanese stock or an American stock? The majority of its income is generated in the United States. Is Coca Cola an American stock or an International stock? The majority of its income is from outside the United States. A large proportion of the earnings for many American companies are generated abroad. As a result, we are already international investors when we buy a broad index of American companies.
Finally, the Couch Potato portfolio was created to reproduce the broad distribution of financial assets in households. The idea was to transfer attention from the performance of assets, which you can't control, to saving more money, which you can.
Put all that together and the two Couch Potato Portfolios--- 50/50 and 75/25---can serve as a core portfolio, a starting point, or an "escape road" for otherwise disappointed investors.
The moment you start slicing the portfolio into more pieces--- such as the large cap, small cap, foreign stock, fixed income, and cash mixture you mentioned, your investing becomes less actionable. Instead of making a commitment, many investors will fritter with having more or less cash, more or less foreign equity, more or less large cap, etc.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
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