The Couch Potato Portfolio Makes Hedge Funds Look Silly
November 19, 2020

The Couch Potato Portfolio Makes Hedge Funds Look Silly

Imagine a planet similar to ours. Somebody creates a 2-speed bicycle. Others figure they can build something better. They add several gears. Then they add an internal combustion engine. Not long after, an electric engine follows.

And what if, despite their attempts to innovate, these new bikes end up slower? This planet might sound like a backward place. But that topsy-turvy aligns with an investment story here.

In 1991, Scott Burns created the investors’ equivalent of a 2-speed bike. It included an equal split between a U.S. stock market index and a U.S. bond market index. Once a year, investors rebalance the portfolio back to its original allocation.

It’s simple, yet it thrashes the performance of most hedge funds. It beats them when stocks rise. And it beats them when stocks fall.

I first compared hedge funds to Burns’ Couch Potato portfolio back in 2012. For ten years in a row, simplicity beat complexity. Since then, the performance gap between hedge funds and the Couch Potato has grown even wider. Over the past 8 years, the Couch Potato beat the HFRX hedge fund index by almost 7 percent, per year.

Some people might say, “The only reason they lost is because hedge funds are expensive.” That’s partly true. They do cost a lot. The typical hedge fund charges about 2 percent per year, plus 20 percent of any profits earned. In contrast, the Couch Potato portfolio is a far cheaper ride.

Vanguard’s Admiral Series Total Stock Market Index (VTSAX) costs a paltry 0.04 percent per year. The firm’s Admiral Series Inflation Protected Securities Fund (VAIPX) costs just 0.10 percent per year. That puts the Couch Potato’s total annual cost at just 0.07 percent. With Fidelity , you could build a similar portfolio without paying any fees.

But high fees don’t fully explain why hedge funds lag. After all, they lose by a far higher percentage than the fees they charge. In fact, from 2003-2020 hedge funds could have charged no fees , yet the Couch Potato portfolio would have still left them far behind.

How $10,000 Would Have Grown

couch potato vs global hedge fund of 21 years

You might not own a hedge fund. But there’s still a lesson here. Most people invest in portfolios that are far more complex than the simple Couch Potato. But sophistication and profits don’t typically go hand-in-hand.

Hedge fund managers are smart. They work really hard. They use sophisticated strategies in attempts to buy the best stocks, time the market, short the market (if they think stocks will fall) and shift money into alternative investments when they think the time is right. But most hedge funds still lag a simple two-part portfolio for three main reasons:

Nobody can consistently time the market.

Nobody can consistently buy market-beating stocks.

Nobody can consistently shift money into the best alternative asset classes.

That’s why, if hedge fund managers can’t do it, then why would you bother to try?

Instead, build a portfolio of low-cost index funds or ETFs. It could be a 2-speed portfolio like the original Couch Potato. It could be a 3-speed portfolio that includes international stocks. It might even be an all-in-one portfolio of index funds, such as a Target Retirement fund.

Just keep costs low and stay the course.

Scott Burns was right.

Low-cost simplicity trumps sophistication.

Year Global Hedge Funds (HFRX) Couch Potato Portfolio
2003 13.40% 19.68%
2004 2.70% 10.38%
2005 2.70% 4.29%
2006 9.30% 7.97%
2007 4.20% 8.54%
2008 -23.30% -19.94%
2009 13.40% 19.75%
2010 5.20% 11.63%
2011 -8.80% 7.10%
2012 3.51% 11.51%
2013 6.72% 12.22%
2014 -0.58% 8.13%
2015 -3.64% -0.77%
2016 0.86% 8.53%
2017 0.73% 11.93%
2018 -6.70% -3.37%
2019 8.62% 19.35%
2020 (11/09/20) 3.19% 9.48%
Compound Annual Average 1.4%  7.79%

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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 purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.