More money. Less worry.
That’s what most of us want from our investments.
The question is how to get both.
The conventional answer is to invest your money with a fund-manager-hero but that, at best, is an uncertain process.
So I would like to suggest an alternative: Concentrate on a simple portfolio with two basic assets— a stock index fund and a bond index fund. Do that and you’ll enjoy superior performance with less risk.
Skeptical?
I don’t blame you. But recurrent evidence supports simplicity over fund manager selection.
Recently, for instance, I made a study of managed funds versus the two simple Couch Potato Portfolios that use a stock index fund and a bond index fund.
The time period chosen includes some of the best years for stocks in history— 1998 and 1999— but it also includes the decline that has occurred since the market peaked in the spring of 2000.
If you had invested $10,000 at the end of 1995 in the basic Couch Potato Portfolio— the one made by putting half your money in the Vanguard 500 Index fund and the other half in the Vanguard Total Bond Index fund—your investment would have grown to $20,200 by late July. The more aggressive 75/25 Couch Potato— 75 percent equity fund, 25 percent bond fund— would have done better, growing to $20,900.
The same investment in any of the three large capitalization managed fund types would have grown less.
The average large growth fund portfolio, the best of the three major categories, only grew to $19,400. Worse, your investment would have been subject to harrowing losses, having declined from $28,000 at the end of 1998. That’s a 31 percent plunge.
The table below compares how an initial $10,000 investment would have grown in each of five portfolios— the simple 50/50 Couch Potato Portfolio, the 75/25 Couch Potato Growth Portfolio, the average large capitalization blend fund, the average large cap growth fund, and the average large cap value fund.
The Couch Potato Portfolios During A Period of Upheaval
| Time Period | 50/50 CP | 75/25 CP | Avg. Large Blend | Avg. Large Growth | Avg. Large Value |
| 7/27/2001 | $20,200 | $20,900 | $18,800 | $19,400 | $19,200 |
| 2000 | $20,500 (H) | $21,900 | $20,900 | $24,000 | $19,600 (H) |
| 1999 | $20,200 | $22,800 (H) | $22,400 (H) | $28,000 (H) | $18,400 |
| 1998 | $18,200 | $19,600 | $18,800 | $19,800 | $17,300 |
| 1997 | $15,400 | $15,900 | $15,400 | $14,900 | $15,300 |
| 1996 | $12,700 | $12,500 | $12,100 | $11,900 | $12,100 |
| End 1995 | $10,000 | $10,000 | $10,000 | $10,000 | $10,000 |
| Risk Index* | 100 | 135 | 168 | 234 | 151 |
Source: Morningstar Principia Pro database and Morningstar website, www.morningstar.com (The risk index is calculated by dividing the standard deviation of each fund by the standard deviation of the 50/50 Couch Potato portfolio. This provides a measure of relative risk.) Bold type indicates the highest performance in each period.
These results don’t conform to investment theory.
If theory ruled the world, each of the equity fund categories would have left the mixed portfolios in the dust. After all, common stocks provide long term returns over 11 percent while bonds return half that much. Mix bonds with stocks and your return will decline. The difference would be particularly dramatic during the final years of a major bull market.
Real money tells a different story.
You might have felt a bit silly at the end of 1999 with your money invested anywhere but growth stock funds. Many did. But you were riding an investment yo-yo, heading for the 31 percent decline that followed.
The Couch Potato Investor, on the other hand, saw his investment double in 4 years. Later, he saw most of his stock market losses offset by bond market gains. The 50/50 Couch Potato portfolio has lost only 1 percent since its high at the end of 2000. The 75/25 Couch Potato portfolio has lost only 8 percent since its high at the end of 1999. Either way, the losses are a lot less painful than a 31 percent decline in growth funds or a 16 percent drop in large cap blend funds.
Bottom Line: Simple asset diversification, using index funds, reduces risk. Diversification helps you get through difficult periods.
If you’ve been chasing “winning funds,” maybe it’s time to accept the idea that simplicity is superior to chance.
Photo: by Anna Nekrashevich from Pexels
(c) A. M. Universal, 2001