The couch-potato portfolio is an indexing investment strategy that requires only yearly monitoring by an investor. It is a passive investing strategy designed for the long-run investor who is willing to leave their funds alone. If you are interested in a more hands-on approach and like to watch and react to the stock market, this strategy is not for you.
Building the Portfolio
Scott Burns, personal finance writer, 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. Burns' initial recipe was simple.
An investor can implement this strategy by putting half their money into a common stock fund such as the Standard & Poor's 500 Index (S&P 500) and the other half into a total bond fund market that mimics the Bloomberg Barclays US Aggregate Bond Index for intermediate maturity bonds.
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 Total Bond Market Index Fund (VBMFX). 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 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, 50% into the Bond Index, and rebalancing at the beginning of each year).
The annualized rate of return for the S&P 500 has averaged 9.8% over the last 90 years although there have been definite periods of extreme volatility. Bond investments are designed to be much more conservative than stocks. The couch-potato portfolio is designed to use 50% of the S&P 500 and 50% of the bond index to reduce the volatility of a portfolio at a low cost and with minimal effort for the investor.
Weighing Couch-potato Portfolio Returns
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, 2000 to 2002, the S&P 500 lost 43.1% overall, whereas the couch-potato portfolio lost only 6.3% during the same period.
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 over passive strategies although 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.