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 >>
  2. Is it possible to invest in an index?

    First, let's review the definition of an index. An index is essentially an imaginary portfolio of securities representing ... Read Answer >>
  3. What are the pros and cons of using the S&P 500 as a benchmark?

    Learn about the advantages and disadvantages of using the S&P 500 as a benchmark for portfolio performance, and understand ... Read Answer >>
  4. Why do index funds tend to have low expense ratios?

    Understand what an index fund is and why the nature of index funds causes them to have lower expense ratios than more actively ... Read Answer >>
  5. What is the average annual return for the S&P 500?

    See the historical performance of the S&P 500 Index, and examine a number of factors that affect an investor's actual return ... Read Answer >>
  6. How can I buy an S&P 500 fund?

    In 1976, Vanguard introduced individual investors to the first mutual fund designed to mimic the S&P 500 Index. Today ... Read Answer >>
Related Articles
  1. Trading

    Top 4 Strategies For Managing A Bond Portfolio

    Find out how these strategies work and how you can put them to work for you.
  2. Managing Wealth

    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.
  3. ETFs & Mutual Funds

    A Guide To Core-Satellite Investing

    Find out how this approach reduces risk and costs so you can maximize your portfolio's return.
  4. ETFs & Mutual Funds

    VBMFX: Overview of Vanguard Total Bond Market Index

    Learn about the world's largest fund, the Vanguard Total Bond Market Index Fund, including its performance and portfolio highlights.
  5. ETFs & Mutual Funds

    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. ...
  6. ETFs & Mutual Funds

    Bond Funds Boost Income, Reduce Risk

    These funds can provide stable returns for those who depend on their investment income.
  7. Financial Advisor

    Beware: These Bond Funds Act Like Stocks

    Beware of bond funds that act like stocks.
  8. ETFs & Mutual Funds

    Lowering Portfolio Volatility With Certain Bond ETFs (AGG, BND)

    Learn about how overall portfolio risk can be reduced by adding a variety of different types of bond ETFs to a primarily stock portfolio.
  9. Trading

    Adding Alpha Without Adding Risk

    Learn how to generate higher returns in your portfolio while keeping the same risk profile.
  10. ETFs & Mutual Funds

    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.
RELATED TERMS
  1. Index Fund

    An index fund is a type of mutual fund with a portfolio constructed ...
  2. Total Bond Fund

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

    An index used by bond funds as a benchmark to measure their relative ...
  4. Standard & Poor's 500 Index - S&P 500

    An index of 500 stocks chosen for market size, liquidity and ...
  5. Trading Effect

    A measure of performance that examines the difference in returns ...
  6. Index Futures

    A futures contract on a stock or financial index. For each index ...
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center