Mas Tequila! The 2004 Couch Potato Portfolio Report

Eternal vigilance.

This is what builds 10,000 square foot log cabins in Jackson Hole Wyoming. That and big investment management fees. It may not make you and me rich— since the fees reduce our return—but they do right well, thank you.

Well, we can fix that. We can also improve the odds of enjoying a well-financed retirement.

All we have to do is virtually nothing. We have to be slow, plodding, couch potatoes. That’s harder than it looks, of course—but worth the lack of effort. Had you invested half your money in the average managed domestic equity fund and half in the average managed intermediate bond fund, your 2004 return would have been 7.15 percent. Do the same with two index funds and your return would have been 7.45 percent.

That’s a small reward— 0.30 percent—but it doesn’t count the commission costs of the typical retail investment program. Also, we’re only talking about a single year.

The key, which I have been touting in this column for about 15 years, is to pay attention to the obvious: fees and expenses.

The more we squeeze out of fees and expenses, the greater the odds our long-term result will be good.  Multiple studies have shown that index investing will beat about 70 percent of all active managers.

While Vanguard was virtually the only retail index shop 15 years ago, we can now buy broad market indices from a great number of fund companies. We can also buy shares of Exchange Traded Funds that do the same thing— duplicate the performance of an index. Devote ourselves to index funds and we can increase our investment returns by anywhere between 1.3 and over 2 percent a year. The amount saved depends on the visible annual expense ratio, the less visible commission costs, and the invisible turnover costs.

The original Couch Potato portfolio was designed to be as simple as possible. We achieved diversification, of sorts, by putting half our money in the S&P 500 index (which accounts for 75 percent of all stock market value in America). The other half went into the Vanguard Total Bond Index. Unlike a great many of the things we see on TV today, this is something we can do in our spare time at home, without adult supervision.

Later, I added the 75/25 Couch Potato for young readers who could take more risk while showing off their ability to deal with fractions.

Still later, I substituted the Vanguard Total Market Index for the S&P 500 Index as a way to incorporate small and mid cap stock returns. While the Vanguard 500 Index has been available since late 1976, the Total Market Index has only been available since 1992. As you can see in the table below, switching to the Total Market Index has been beneficial— returns have consistently been slightly better than returns for the original Couch Potato portfolio.

Early last year I introduced a new Couch Potato portfolio that uses three funds. Called the Margarita Portfolio in honor of Jimmy Buffett, the Buffett who sings about cheeseburgers, this portfolio is made of three equal parts Vanguard Total Stock Market, Vanguard Total International Stock Market, and Vanguard Inflation Protected Securities. It returned 13.21 percent last year and 10.94 percent over the last three years, handily beating both the earlier Couch Potato Portfolios. At the same time, it provides greater diversification and inflation protection.  It should be noted that the Margarita Portfolio had two powerful advantages over the last three years— the move to realistic pricing for Treasury Inflation Protected Securities and the rise of international stocks after years of under-performance relative to U.S. stocks.  (See figures below)

Over time, my expectation is that the Margarita Portfolio will provide a higher risk-adjusted return than the earlier passive portfolios because it is more diversified. It does require that you know how to make a Margarita.

This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Photo: by Helena Lopes

(c) A. M. Universal, 2005