You will recall the principals of Couch Potato investing:
1) you must show proof that you can fog a mirror; 2) and are capable of dividing by the number "2"… with the assistance of a pocket calculator.
If you can do that, you then put half of your money in a common stock index fund and the other half in an index fund for the bond market or, better still, intermediate government bonds. Then, as the spirit moves you, you can do the complex task of "rebalancing" your portfolio whenever there is a need to impress your neighbors. ( You do this by taking your total portfolio, dividing by "2", and moving some money from one fund to another so the piles are equal.)
Our research, done courtesy of "Returns" software and data from Dimensional Funds Advisors in Santa Monica, California, has shown that this passive approach to investment will yield rather nice results. From January, 1973 to the present, for instance, a 100 percent stock portfolio invested in the Standard and Poor's 500 index would have provided an annualized return of 11.3 percent. The Couch Potato portfolio would have provided a return of 10.8 percent--- a modest difference given the major improvement in sleep you would have enjoyed over the period. Here is how the Couch Potato Portfolio compares to an all stock index over different periods:
The Couch Potato versus The Big Bogey
|Period||Standard & Poors' 500||50/50 Couch Potato|
|23+ Years 1/1/73-6/30/96||11.3%||10.8%|
|Bear Market (1/1/73-6/30/82)||4.0||5.8|
|Bull Market 7/1/82-6/30/96||17.8||14.4|
Source: Dimensional Funds Advisors
As you can see, the Couch Potato beat the all-stock portfolio during the grinding bear market of 73-82 and has trailed since the beginning of the current bull market in mid-1982. The bull market performance gap, however, shrinks when you measure against real mutual funds because no category of fund did better, on average, than the S&P Index. The average Growth and Income fund, for instance, provided a return of 15.4 percent, only 1 percent better than the Couch Potato but 2.4 percent worse than the S&P 500 Index.
But what has the Couch Potato done for us lately?
Not much. As this bull market has aged and returns on fixed income funds have trailed returns on equity funds, the performance gap between the Couch Potato and the average equity fund has grown. Here are the figures for the last 3, 5, 10, and 15 year periods:
|Category||3 years||5 years||10 years||15 years|
|Growth & Inc.||14.5||14.2||11.5||13.7|
|Couch Potato 50/50||10.9||11.6||11.2||13.4|
|Couch Potato 75/25||14.0%||13.7||12.5||14.6|
Source: Morningstar Principia
Over the 10 and 15 year periods, the Couch Potato portfolio trailed the average Growth and Income fund by only 0.3 percent, a gap smaller than the typical downward adjustment necessary to reflect the cost of buying a load mutual fund. Basically, you would have been as well off, on average, executing the Couch Potato portfolio as getting professional advice and you would have had a lot less risk.
In the last 3 and 5 year periods, however, the gap has grown. The Couch Potato portfolio would have been in the bottom 25 percent of all Growth and Income funds although it has continued to beat fixed income funds, balanced funds, asset allocation funds, and foreign stock funds. Given the average returns of the underlying groups, there is a good chance that the Couch Potato did better than a great many portfolios that have been "optimized" with exotic software… but it appears that our Couch Potato free lunch, good returns with less risk, has disappeared.
Is there a way to do better, to make certain that we do as well as most equity investors?
We've got two choices. The first requires a Zen-like inner fortitude: wait with sublime assurance that things will change as they have in the past.
The other may require some previously unexercised intellectual fortitude. If we divide by "4" and multiply by "3" ( a massive escalation of our earlier efforts) we can produce a 75 percent equities/ 25 percent fixed income Couch Potato, beating the average growth and income fund over the last 10 and 15 years and reducing the gap for the last 3 and 5 years down to a comfortable one-half of one percent.
Either way, the numbers continue to show that the only way professionals have a chance of beating a passive approach is to take more risk with a 100 percent stock portfolio.