A:

The couch-potato portfolio is an indexing investment strategy that requires only yearly monitoring by an investor. An investor can implement this strategy by putting half of his or her money into a common stock fund that tracks the Standard & Poor's 500 Index (S&P 500) and the other half into a fund that mimics the Lehman U.S. Aggregate Bond Index for intermediate maturity bonds. At the beginning of each new year, the investor only needs to divide the total portfolio value by two and then rebalance the portfolio by putting half of the funds into the S&P 500 and the other half into the Bond Index.

Let's take a look at how the couch-potato model would have performed in relation to the S&P 500 and Bond Index (based on placing 50% of funds into the S&P 500 and 50% into the Bond Index and rebalancing at the beginning of each year).

Historical Returns Study (1997- 2007)


Year
S&P 500
Bond Index
Couch-Potato

1997
33.4
9.65
21.5

1998


28.6
8.69
18.6

1999
21.0
-0.82
10.1

2000
-9.1
11.63
1.3

2001
-11.9
8.44
-1.7

2002
-22.1
10.26
-5.9

2003
28.7
4.10
16.4

2004
10.9
4.34
7.6

2005
4.9
2.43
3.7

2006
15.8
4.33
10.1

2007
5.5
6.97
6.2

Average
9.61
6.37
7.99

Bond investments are designed to be much more conservative than stocks. The couch-potato portfolio is designed to utilize 50% of the S&P 500 and 50% of the Bond Index to reduce the volatility of a portfolio at low cost and minimal effort to the investor. In rising stock market conditions, the S&P 500 will typically outperform bond investments, but with greater returns comes increased exposure to risk. During one of the worst bear market periods in U.S. history, from 2000-2002, the S&P 500 lost 43.1% overall, whereas, the couch-potato portfolio lost only 6.3% during the same period. Based on the 11-year study above, an investor would have given up 1.62% in additional annual return (average 9.61 minus 7.99) by using the couch-potato model.

Investors can benefit considerably by implementing a more sophisticated indexing strategy using multiple asset classes and by adding small and international stocks to boost returns. Some investors still prefer active management strategies even though studies have shown that 80% of managers do not beat the comparable index. The couch-potato strategy works for investors who want low cost and little maintenance in a portfolio that contains only U.S. stocks and bonds. Such investors sleep well at night knowing their risk is reduced by not having 100% of funds tied up in the stock market.

(For more on this topic, read How Portfolio Laziness Pays Off and Five Quick Research Tips for Busy Investors.)

This question was answered by Steven Merkel.

RELATED FAQS
  1. What does "buy and hold" mean?

    Buy and hold refers to an investing strategy practiced favorably by passive investors (or couch-potato investors). When buying ... Read Answer >>
Related Articles
  1. Investing

    Why It Pays To Be A Lazy Investor

    Be a couch potato! This passive, but diversified, investing strategy could be for you.
  2. Investing

    Top 4 Strategies For Managing A Bond Portfolio

    Find out how these strategies work and how you can put them to work for you.
  3. Investing

    3 Index Funds with the Lowest Expense Ratios

    Read detailed information about index mutual funds with some of the lowest expense ratios in their categories, and learn about their pros and cons.
  4. Investing

    Evaluating Bond Funds: Keeping It Simple

    Discover some of the key factors for determining a fund's risk-return profile.
  5. Investing

    Bond Funds Boost Income, Reduce Risk

    These funds can provide stable returns for those who depend on their investment income.
  6. Investing

    A Guide To Core-Satellite Investing

    Find out how this approach reduces risk and costs so you can maximize your portfolio's return.
  7. Investing

    What are Index Funds?

    An index fund is a type of mutual fund that is tied to a broad stock index like the S&P 500 or the Dow Jones Industrial Average, instead of being handpicked and managed by an investment manager. ...
  8. Investing

    The Top 5 Bond Mutual Funds for 2016

    Learn about bond mutual funds that investors may want to consider for 2016. Understand why the risk of rising interest rates is a concern heading into 2016.
  9. Investing

    The Top 5 Long-Term Bond Funds for 2016

    Understand how long-term bond mutual funds can benefit an investor's portfolio, and learn the best long-term bond mutual funds for 2016.
  10. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
RELATED TERMS
  1. Total Bond Fund

    A mutual fund or exchange-traded fund that seeks to replicate ...
  2. Lehman Aggregate Bond Index

    An index used by bond funds as a benchmark to measure their relative ...
  3. Index

    A statistical measure of change in an economy or a securities ...
  4. Trading Effect

    A measure of performance that examines the difference in returns ...
  5. Bond Laddering

    A portfolio management strategy and model for investing in fixed ...
  6. S&P Phenomenon

    The tendency for a stock that has been recently added to the ...
Hot Definitions
  1. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  2. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  3. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  4. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  5. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
  6. Impaired Asset

    A company's asset that is worth less on the market than the value listed on the company's balance sheet. This will result ...
Trading Center