Couch PotatoHow did Couch Potato investors do last year?

Well, let’s just say we’re the prettiest corpse in the morgue. As usual, slothful and inexpensive Couch Potato investing did better than most of the expensive and hard-charging managed competition.

But the losses are still terrible.

In 2008 the most basic Couch Potato portfolio, a careful mixture of 50 percent Vanguard Total Stock Market Index fund and 50 percent Vanguard Inflation-Protected Securities, lost 20.4 percent of its value. No one likes to lose that much money. Ever.

But the average managed fund did a lot worse.

The average fund that Morningstar calls “moderate allocation” (more commonly called a “balanced” fund) lost 28 percent of its value. The average “world allocation” fund in the Morningstar database lost a whopping 29.1 percent. Both of these fund categories now include foreign equities as well as domestic equities. But the world allocation funds, as their name suggests, typically hold more in international stocks. While the average world allocation fund has nearly 30 percent of its assets in international stocks, the average moderate allocation fund has only 10 percent.

As a practical matter, it really didn’t matter where you were invested in equities last year. The decline was global. There was no place to hide: Wherever they were, equities were taken out and shot. Unless you invested in government securities, you were likely to lose money in bonds as well. Investors in corporate or municipal bonds suffered losses.

The real surprise here isn’t that lazy and cheap investing did better than expensive active investing. I’ve been telling you that story, and documenting it, for decades. The real surprise is that bear markets are where lazy index investing is supposed to fail, while clever managed investing is supposed to succeed. But that didn’t happen.

The reason managed investing should beat index investing in a bear market has nothing to do with the supposed smarts of those on Wall Street. It has been painfully demonstrated that Wall Street is populated by witless greed freaks. Managed funds should beat index funds in a bear market because index funds are always fully invested, while managed funds hold some cash. As a consequence, managed funds have the advantage of some cash in a bear market and the disadvantage of, yes, some cash in a bull market. In other words, managed funds should have the benefit of dumb luck in bear markets.

If there was ever a year to be holding cash, it was 2008. The domestic stock market lost 37 percent. The international markets lost even more, 44 percent.

In spite of that, our cheap, lazy and passive approach beat the average managed fund by 8 percentage points. 

In fairness, this isn’t the whole story. The most basic Couch Potato portfolio is one part equities and one part fixed-income. That’s 50 percent equities. (Other Couch Potato portfolios have up to 10 building blocks and can hold up to 80 percent equities. For monthly performance updates on all of these portfolios, visit my website.) The typical moderate allocation fund is 60 percent equities. World allocation funds are about the same. In a devastating year like 2008, a 10 percent difference in equity allocation makes a big difference in performance.

In fact, managed investing still fails when you compare it to the Couch Potato portfolios that have comparable equity allocations. The Five-Fold Couch Potato portfolio--- built with 20 percent allocations to domestic equities, TIPS, international equities, international bonds and REITs--- has a 60 percent equity allocation. It lost 24.39 percent in 2008, easily beating the average moderate and world allocation funds. Ranked against these funds by percentile, the Five-Fold Couch Potato portfolio beat 70 percent of all world allocation funds and 79 percent of all moderate allocation funds. (See the scoring of several Couch Potato portfolios in the table below.)

Simple Couch Potato Portfolios Win, Block by Block
The Couch Potato Building Block portfolios are built with equal investments in from 2 to 10 index fund building blocks. While inexpensive index funds are used as often as possible, it has been practical at times to use a non-index alternative. These results include the use of American Century International Bond fund in portfolios with 4 or more parts. Results would be improved by 27 to 40 basis points if the SPDR International Treasury exchange-traded index fund had been used. Couch Potato Performance would also have been improved somewhat if iShares Barclays TIPS bond exchange-traded index fund had been used rather than Vanguard Inflation Protected Securities fund. (The Vanguard fund is a managed fund but is managed close to the Barclays TIPS index according to Morningstar.)
Portfolio Percent Equities 2008 Performance Percentile against World Allocation funds Percentile against Moderate Allocation funds
Basic Couch Potato (2 funds) 50 (20.45) 16 10
Margarita (3 funds) 67 (28.68) 42 53
Four Square (4 funds) 50 (21.22) 20 11
Five Fold (5 funds) 60 (24.39) 30 21
Six Way (6 funds) 67 (26.60) 37 36
Avg. Moderate Allocation 60 (28.03) Na Na
Avg. World Allocation 60 (29.12) Na Na
Source:Morningstar, AssetBuilder

Couch Potato investing may not protect you from losing money, but at least you won’t have to pay through the nose to do it.

On the web:

Monthly update of Couch Potato Building Block portfolio performance:<

Column collection on Couch Potato Investing:

March, 2005 Column introducing the Building Block Portfolios

A Couch Potato Building Block Portfolios “Cookbook”: