Never forget the three S's of Investing.

Simplicity.

Sloth.

Stupor.

Yes, it's time for our annual Couch Potato Portfolio Review. This is the money you can manage from Margaritaville.

You will recall that the Couch Potato Portfolios don't require high-speed Internet access. You won't have to enroll for an MBA in Modern Portfolio Theory, either. You won't even need a working familiarity with asymmetry or skewness, let alone game theory or chaos theory.

The discipline of the Couch Potato is different.

You must be able to divide by the number "2." You must be completely inattentive 364 days a year, regardless of what you hear on CNBC. On the 365th day, you descend from sublime indifference. You restore your portfolio to its chosen balance. You should do this is five minutes or less.

Some readers will think this is easy. In fact, being a Couch Potato Investor means you have a lot of spare time. This means you will need to develop a life of your own, which is far from easy.

There are two Couch Potato recipes:
  • The Traditional CP is a 50/50 mixture of Vanguard 500 Index fund and Vanguard Total Bond Market Index fund. Each requires a minimum initial investment of $3,000 and having annual expenses of 0.18 percent and 0.22 percent annually.
  • The Sophisticated CP is a 75/25 mixture of the same funds, with more invested in the 500 Index fund. This involves more math, more risk, and a certain jauntiness.
So how did sloth and indifference do?

Quite fine, thank you.

The Traditional 50/50 Couch Potato lost only 1.80 percent compared to the 11.32 percent loss suffered by the average domestic equity fund. Ranked, the 50/50 would have placed 1,646th of 6,995 domestic equity funds in operation for the year. That means it did better than 76 percent of all domestic equity funds.

It could be argued that this is a cheap shot, since bonds did well while stocks tanked last year. But the long-term record provides ample support for sloth. Whether you examine 3, 5, 10, or 15 years, the Couch Potato Portfolios blow away the average balanced fund.

They do pretty well against pure equity funds, too. Over the last 15 years, for instance, the 50/50 Couch Potato provided an annualized compound return of 10.96 percent. The 75/25 CP provided a compound return of 12.30 percent. The average balanced fund returned 9.45 percent and the average domestic equity fund returned 11.85 percent. (Comparisons for all time periods are shown in the table below.)
The Couch Potato Portfolios vs. Balanced and Domestic Equity Funds
Period 50/50 CP 75/25 CP Average Balanced Average Domestic Equity
1 year -1.80 -6.91 -4.01 -11.32
3 years 2.89 1.22 2.21 + 3.33
5 years 9.66 10.29 7.01 8.72
10 years 10.37 11.68 8.98 11.27
15 years 10.96 12.30 9.45 11.85
Source: Morningstar Principia Pro, December 31, 2001 data
As you can see from the table, the 50/50 CP beat the average balanced fund over all 5-time periods. Similarly, the 75/25 CP beat the average domestic equity fund in four of the five time periods. While this may seem a slight achievement---since so few of us aspire to being average---these returns were achieved with less risk.

The standard deviation (a measure of volatility or risk) of the average domestic equity mutual fund over the last three years was 22.87 percent. The volatility of the Vanguard 500 Index was 16.88 percent and the Total Bond Market Index fund volatility was only 3.53 percent. The 75/25 CP achieved greater returns with about 60 percent of the risk, something Couch Potato investors deeply appreciated during the last two years. The volatility of the average balanced fund was about the same as the 50/50 CP--- but the passive portfolio performed better than the average managed balanced fund across the board.

Read more about the history, development and performance of the Couch Potato Portfolios