Q. Regarding your recent (5/2/2000) column on government bond funds. You say that most fixed-income funds have no reason to exist, but you advise "couch potato" investors to have a 50/50 or 75/25 mix of stocks/bonds in their portfolios. So, are you advising to get out of bond and treasury funds and instead purchase 5 year T-notes?

I am currently invested in 3 funds with Vanguard: 500 Index, Total Stock Index, and Intermediate Term Treasury fund, with a mix of 75% in the 2 equity funds, with the remainder in the fixed-income fund.   My monthly investments are split amongst these 3 funds in approximately the same ratio. Is this good, bad or too complicated even for a couch potato?

---A.W., by email


A. You aren't alone. Many readers were curious about this. The short answer is that when you are accumulating for retirement you should pick one of the government funds that has consistently done better than the 5 year Treasury. Vanguard GNMA does this and has beaten the vast majority of government funds cold.   This will give you a higher return while providing a convenient tool for reinvesting income.

Those who are already retired should dump their fixed income funds and build a ladder based on the 5 year Treasury. This will get them the return on the 5-year Treasury and an average maturity of about 2.5 years.

Now let me tell you the why.

I started doing the Couch Potato Portfolio research many years before I started doing the government bond fund research. The object of the Couch Potato research was to see if there was a simple way to get a competitive, lower risk long-term return from mutual funds.

That research regularly shows that a combination of two low cost index funds, one for the S&P 500 Index which accounts for over 80 percent of all domestic market value and the other for the U.S. fixed income market, would produce the returns necessary for a successful retirement and do as well as or better than most managed equity funds. I started with a 50/50 split and added the option of being slightly more complicated and investing 75 percent equities, 25 percent fixed income.

Later, I noticed that much of my reader mail was about disappointments in the bond funds being purchased as an alternative to low yield CDs. So I started to measure major government bond funds against the performance of a 5-year Treasury. That research has regularly shown that if you purchase a 5-year Treasury and spend the interest income, the Treasury will do better than government bond funds.

The distinction about spending the income is important because most investment research is about accumulating assets. It assumes that you regularly add to your savings and reinvest all income. But eventually we all must start taking income from our savings.

Finally, it turns out that portfolios that are making distributions need to be managed differently from portfolios that are accumulating.

Why?   Withdrawals change results dramatically. I learned this in 1995 when Peter Lynch wrote that investors could have a 100 percent stock portfolio and withdraw from it at a 7 percent rate forever, eliminating the need for any fixed income investments altogether. Unfortunately, Mr. Lynch was wrong. When I tested that idea with help from Ken Bingham, a broker at Paine Webber in Dallas, it turned out that there were periods when a 7 percent withdrawal rate would leave you broke. Since then I've been looking for research on long-term portfolio survival. (You can find all of this material on my website, www.scottburns.com, under Couch Potato investing, Portfolio Survival, and Special Collections.)