A few words attributed to Winston Churchill could well describe what I call “Couch Potato” investors for 2013. Speaking of Labor Party leader Clement Attlee, Churchill said: “A modest man, with much to be modest about.”
The basic Couch Potato portfolio returned a very modest 10.41 percent for 2013. That’s less than the 14.36 percent of the original Couch Potato portfolio and less than the 16.38 percent of the average mutual fund that Morningstar describes as “moderate allocation.” If there were a need to restore humility, this would certainly do it.
What is Couch Potato investing or the Couch Potato portfolio, you ask?
Well, the idea is very simple. Fundamentally, it is to treat our money the opposite of the way it is treated by Wall Street.
Where Wall Street seeks news, activity and the reading of entrails, the Couch Potato investor thrives on sleep and sloth.
Where Wall Street adores complexity and big ideas that can’t be thought about without a very large computer, the Couch Potato investor is passionate about simplicity. While he may choose a more complicated portfolio than the basic Couch Potato, he will always invest equal amounts of money in each asset class, a principle fostered by the wisdom of Margarita construction.
And where Wall Street will fearlessly spend our principal on brilliant management and its need for the most expensive automobiles money can buy, the Couch Potato investor says, “Bah, humbug!” He believes that a penny of return saved is a penny in his pocket, not someone else’s.
In most years, the Couch Potato approach pays off nicely, beating about 70 percent of all the diligent effort and extravagance that Wall Street is so proud of.
But not in 2013. Indeed, 2013 was so severe, its damage extends out 10 years. The return of the basic Couch Potato portfolio over the last 10 years was an annualized 6.32 percent. That’s better than the 6.10 percent return of the average moderate allocation fund, and it still beats 61 percent of its managed competition, but it is a significant comedown from beating 70 percent.
So, like it or not, we face a need to awaken from our slumber. We need to ask some fundamental questions. Things like this hurt our heads, so we’re going to do it fast. The first question is: What caused the drop?
Answer: It was a single fund — the inflation-protected securities fund that holds half of the invested money. After years of very good performance, the Vanguard Inflation-Protected Securities Fund took a big hit when interest rates reversed direction and inflation expectations fell in the late spring of last year. So did all the other funds investing in inflation-protected securities.
For the year, the fund lost 8.92 percent. That’s a major loss for a bond fund. Had the money been in the Total Bond Market Index fund, which lost “only” 2.21 percent for the year, the return for the portfolio would have been 14.36 percent.
Does this mean we should abandon inflation protection in our fixed-income investing? I don’t think so. While the performance difference is large for 2013, it is minor over longer periods, clocking in at 0.03 percent over the last three years, 0.15 percent over the last five years and 0.20 percent over the last 10 years. Since it usually isn’t a disadvantage and could be very valuable in a period of greater inflation, anyone who thinks future inflation may be greater than 2 percent should keep the fund.
The Couch Potato portfolio also commits only half of its money to equities, while the typical moderate allocation fund commits 60 percent. This reduces risk and makes it easier to sleep. It also reduces return in big bull market years like 2013. One indication is that if the Couch Potato portfolio had been invested 60/40 (requiring all that dreary calculation), it would have returned 14.73 percent for the year, not 10.41 percent. For cautious investors who hate the ups and downs of the stock market, however, the simple 50/50 portfolio remains the easy path to better sleep.
Couch Potato investors also have a good conversation point for cocktail parties. The 10.41 percent return of the basic Couch Potato portfolio trounced the 7.4 percent return of the average hedge fund — by doing the exact opposite of what Wall Street does, as epitomized by the ridiculous existence of some 2,257 funds in the Bloomberg Hedge Funds Aggregate Index.
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