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)
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.
This question was answered by Steven Merkel.