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Beating up on Couch Potatoes

by Ram Balakrishnan
August 2, 2011
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In a recent post titled Why this is no market for Couch Potatoes, Balance Junkie took issue with a recent column in MoneySense magazine (See A cure for Potato performance anxiety, June 2011). In his magazine column, Canadian Couch Potato argued that passive investors should stick with their plan even though index portfolio returns in the recent past were rather modest. The Global Couch Potato composed of 40% bonds and 20% each in Canadian stocks, US and EAFE stocks returned 4.0% (or 1.2% in inflation-adjusted terms) in the 2001-10 time period. The irony here is that most average investors I know would look at their own portfolios devastated by expenses and performance chasing and gladly take 4% over the past 10 years. Still, Balance Junkie says that in a secular bear market, a Couch Potato strategy is not effective:

I have written over and over again that we are in a secular bear market that began in 2000. If you took that into account, you wouldn’t be at all surprised to see below-average returns for the Couch Potato portfolio over the last decade. The 20-year period before 2000 was a secular bull market. The Couch Potato approach would have worked beautifully during that time period, but it won’t be effective in a secular bear market.

First, it is not true that all Couch Potatoes are invested 100% in stocks all the time. As a (relatively) young investor with a spouse who has one of those nice defined benefit pension plans, we have a 20% allocation to bonds in our retirement accounts but an older, retired Couch Potato might have 100% in bonds. The point is a Couch Potato takes risks she is able and willing to take.

It should also be hardly surprising that investors with the bulk of their funds in the stock market experience poor returns from time to time. For instance, in the 10-year period 1973 to 1982, the Global Couch Potato would have returned 9.43%. That sounds great, except that the returns work out to just 0.85% in real terms. (And just an aside, a Couch Potato who persisted with the strategy would have earned 9.67% in real terms over the next decade). It is true that an investor who can nimbly move out of assets before they start underperforming and into assets before they start outperforming can do much better. There is only one little problem: the average, retail investor has pretty much zero chance of doing it consistently (and the record of professionals after fees and expenses isn’t anything to write about either).

Third, a well-diversified Couch Potato already takes advantage of market fluctuations by rebalancing her portfolio. Anyone can pull up a long-term chart and see for themselves that stock returns (at least in certain markets) since 2000 haven’t been great. It is much harder to correctly anticipate market conditions and adjust one’s portfolio accordingly. So, those who aren’t happy with Couch Potato returns should ask themselves: Were my returns any better? Was it skill or merely luck?

Related posts:

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  4. Notes from the Berkshire Hathaway Annual Report
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