The couch-potato portfolio is an indexing investment strategy that requires only annual monitoring. It is a passive strategy designed for the investor who has a long-term horizon and who willing to leave their funds alone. If you are interested in a more hands-on approach, if you like to watch and react to the stock market, this strategy is not for you.
- The couch-potato portfolio is an indexing strategy that requires only annual monitoring and rebalancing but offers significant returns in the long run.
- Couch potato portfolios invest equally in two assets, common stocks and bonds (via index funds or ETFs), and maintain this 50/50 split year in and year out.
- In the couch potato portfolio, the equities allow for growth, while the debt instruments provide protection against market volatility.
- Couch potato portfolios decline less than the market in down periods but also appreciate less in up markets.
Building the Couch Potato Portfolio
Scott Burns, a personal finance writer and co-founder of Assetbuilder.com, developed the Couch Potato Investing Strategy in 1991 as an alternative for people who were paying money managers to handle their investments. Couch-potato portfolios are low maintenance and low cost and they require minimal time to set up.
The strategy is a simple one: Split one's holdings equally between stocks (equities) and bonds (debt). Since bond investments are designed to be much more conservative than stocks, this approach allows for appreciation, while reducing the volatility of a portfolio at a low cost and with minimal effort for the investor.
An investor creates a couch potato portfolio by putting half their money into a common stock fund that tracks the market, such as the Standard & Poor's 500 Index (S&P 500), and the other half into an intermediate bond fund that tracks the Bloomberg Barclays US Aggregate Bond Index.
While not obligatory, Burns also suggested two index funds in addition that correlate with the described asset classes: the Vanguard Index 500 Fund (VFINX) and the Vanguard Vanguard Fixed Income Short Term Government Bond Fund. But there are many other index funds to choose from.
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 common stocks and the other half into bonds.
Weighing Couch Potato Portfolio Returns
Let's take a look at how the couch-potato model—placing 50% of funds into the S&P 500, 50% into the bond index, and rebalancing at the beginning of each year—would have performed in relation to the stock market.
In one of his original articles, Burns noted, "If you had followed this procedure from 1973 to the end of 1990, a period of great ups and downs, traumas, mystifications, and general angst, your return would have been 10.29%, only 0.27% less than the return on stocks. You would have had about half the ups and downs of the market and you would have beaten somewhere between 50 and 70% of all professional money managers."
During one of the worst bear market periods in U.S. history, 2000 to 2002, the S&P 500 lost 43.1% overall, whereas the couch potato portfolio lost only 6.3% during the same period.
More recently, at the end of 2018—when the market posted losses for the first time in almost a decade—the S&P 500 was down 4.52% (allowing for reinvested dividends). In contrast, a couch potato portfolio, invested in the Vanguard Total Market Index ETF and the iShares Treasury Inflation-Protected Securities Bond ETF, lost only 3.31%.
However, if the couch potato portfolio loses less, it also gains less. Looking at the 10-year period 2010-2019, the S&P 500 has returned 12.97% and the couch potato portfolio 8.48%. As of October 2019, the S&P is up 19.92%, while the couch potato is cooking at 11.06%—hardly small potatoes, but a significant lag nonetheless.
The Bottom Line
The couch potato portfolio fully embraces a passive over an active management approach—the rationale being all those studies that show that 80% of money managers do not beat their benchmark indexes.
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, though of course, they can implement a more sophisticated indexing strategy using multiple asset classes and by adding small and international stocks to boost returns. But the basic idea is a two-asset, two-investment portfolio.
It's the ultimate plant-it-and-forget-it-strategy. While they won't rack up the highest gains, couch potato investors sleep well at night, knowing they can participate in the stock market's growth while knowing their risk is reduced by not having 100% of funds tied up in equities.