Is the Couch Potato portfolio dead?

That question appeared in reader e-mail and on Morningstar's "Vanguard Die-Hard" forum group shortly after my recent column about the new realities of oil.

Reader Robert Verzi was direct. "Does this mean the days of the Couch Potato are over? Have you really taken all your equity money out of the broad market and put it into energy stocks?"

The answer is "NO." As an indecisive mug wump, I would never make an all-or-none investment decision. In a world where many proclaim knowledge of the future but none possess it, investment diversification is a key survival trait.   I pursue low cost investments, usually through index funds. I adopt new investment vehicles when it is appropriate.

The original Couch Potato portfolio was a 50/50 mix of the Vanguard 500 Index Fund and the Vanguard Total Bond Fund. If you can fog a mirror, you can manage a Couch Potato portfolio. When I introduced the Couch Potato in late 1991 there were 31 index funds. Only six had 5-year track records. Vanguard Total Stock Market Fund wasn't introduced until 1992.

In recent years I have suggested using Total Stock Market because it captures 100 percent of the domestic stock market, including all small and micro cap stocks. It's a good replacement for the Vanguard 500 Index fund, which only captures about 85 percent of the domestic equity market. The broader index should capture the higher returns of smaller companies. In theory, it could add about 0.3 percent a year to the long-term return.

I have also suggested that readers who are accumulating their nest egg consider Vanguard Inflation Protected Securities Fund as an alternative to Total Bond Index Fund. Why? Inflation protection.

A Couch Potato portfolio based on Total Stock Market and Total Bond Index would have done quite well compared to the expensive and managed alternatives. Vanguard Balanced Index Fund, a 60/40 mixture of Total Stock Index and Total Bond Index, is a good proxy. Recently, Morningstar ranked it in the 25th, 36th, and 25th percentiles over the preceding three, five, and ten-year periods, respectively, against all moderate allocation (balanced) managed funds. This means the mirror fogging index investor did better than 64 to 75 percent of brilliantly managed funds. A portfolio that used Total Stock Index and Inflation Protected Securities fund, when it became available, would have done somewhat better.

You could do this on your own, without knowing a broker, interviewing financial planners, and without trying to decide between any of 300,000 presentations.

I believe the Couch Potato Portfolio should be the core of most retirement plans. Simple reduction of expenses and turnover gives you a return advantage over more expensive managed funds. It also allows you to eliminate "manager risk" by eliminating the manager darling of the year, month, or week.

Even a small Couch Potato Portfolio commitment can be beneficial. You can measure how your manager is doing relative to the Couch Potato over periods of time. If his management fails to live up to the Couch Potato--- and there is a 50 to 75 percent chance that will happen--- you have a readymade place to put the money you salvage from your managed account. Finally, the same Couch Potato portfolio that you can use to benchmark your chosen manager can also be used to benchmark your personal decisions to invest money elsewhere.

I'll be watching my own decision performance closely because I have little confidence in guessing the future.

While 55 percent of my money is invested in an absolute Couch Potato fashion, I have added further diversification. This reflects my concern--- and bet--- that the dollar is the Achilles heel of our investments. So I have added two asset classes and two sector bets to my portfolio.

The asset classes are international stocks (through index funds) and large residential REITS. They account for 22 percent of assets and 7 percent of assets, respectively. The sector bets--- energy and gold---were not done through index funds. I simply purchased shares in two or more of the largest capitalization stocks in each sector. Think of it as a "homebrew" index.   The energy shares account for 10 percent. The gold shares account for 6 percent.

It's a personalized Couch Potato, but it's still very Couch Potato.  

Sunday, May 30, 2004: Facing oil's ugly realities

Tuesday, December 23, 2003: Summing Up my 2003 investments

Tuesday, September 30, 2003: Trading through a 401(k)

Sunday, January 3, 1988: A Portfolio for All Seasons