Why This Is No Market for Couch Potatoes

Why This Is No Market for Couch Potatoes

Never accept the proposition that just because a solution satisfies a problem, that it must be the only solution.

~Raymond E. Feist

Couch Potato PortfolioUpdate: This article was featured in the Totally Money Carnival at Family Money Values. Thanks!

A recent article in Money Sense magazine offered some data on investment returns for the publication’s preferred investment indexing method: the Global Couch Potato portfolio. It’s a simple, low-cost way to invest in a set allocation of stocks and bonds with limited effort on the part of investors. The rise of ETFs over the past decade has turned this strategy from a questionable alternative to mutual funds to a near standard in the DIY investment space. Many personal finance and investing sites promote it as the best way for individual investors to manage their portfolios.

The strategy grew out of a desire to circumvent the high fees built into mutual funds – the investment fad of the previous decade. It was also a great way to address the reams of data that showed that active managers rarely beat the returns of their benchmark indices. These are very rational goals, and to some extent, the Couch Potato approach accomplishes both of them.

Potato Performance Anxiety

“Don’t think you’re on the right road just because it’s a well-beaten path.”

~Author Unknown

It seems the data shows that this Couch Potato strategy returned 4% per year over the last 10 years. That’s better than nothing, and it’s better than some of the indices. But it’s not much better what you could have achieved with a CDIC-backed 5-year GIC ladder. The fact that many active managers performed worse would be little consolation for many investors. 4% just isn’t as impressive as it was supposed to be.

The explanation for the less-than-average market returns goes like this:

“During the last 85 years, portfolios with a mix of 60% stocks and 40% bonds have averaged well over 8% a year before costs. But during the period I looked at, from 2001 through 2010, market returns were nowhere near that. Canadian equities and bonds did reasonably well, with both delivering more than 6%. But U.S. and international stocks were a train wreck: both had negative returns during that period (as measured in Canadian dollars).”

This type of reliance on broad-based historical data ignores the fact that markets experience both cyclical and secular trends over the long term. It’s fine to allow the averages to smooth out shorter-term cyclical periods, but secular cycles that last 15-20 years can have a meaningful impact on your portfolio. That 15-20 year period could fall within your prime saving/investing years. While the market may average 8% per year over an 85-year time frame, it can and does have long periods of time where returns are nowhere near that level. Those are called secular bear markets.

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.

Dressing for the Wrong Type of Weather

“The only man I know who behaves sensibly is my tailor; he takes my measurements anew each time he sees me. The rest go on with their old measurements and expect me to fit them.”

~George Bernard Shaw

I have no problem with using historical data to help formulate an investment strategy. But you have to use the right context. Using an 85-year context for a 25-year investment time frame probably won’t be very effective. Not too many of us invest for 85 years of our lives. It’s sort of like stepping outside in a bathing suit. It may work in July, but it probably won’t feel great in January – unless you live in Australia.

The same goes for economic expectations. Many economists have been telling investors that the economy has recovered just like it has in every other cyclical downturn over the past 100 years. Again, they are using the wrong context for comparison. There’s more than one type of recession and each requires a different investing mindset.

David Rosenberg has been arguing for years that we are recovering from a balance sheet recession and not a recession triggered by the normal business cycle. If you’re investing for the wrong type of environment, it’s more likely you’ll get hurt. Barry Ritholtz spelled it out for us in a recent Washington Post article: Wall Street Analysts and Economists Have This Recession Recovery Wrong.

Ritholtz also mentions the Reinhart & Rogoff book This Time Is Different. I reviewed the book last year, with the follow observation:

“the economic trajectory after a crisis-induced recession is very different from the one we might see following a normal business cycle-induced recession. Therefore, “standard macroeconomic models calibrated to statistically “normal” growth periods may be of little use.” In that sense, this time is different. It differs from normal cyclical economic activity, but not from what usually happens following a financial crisis.”

So one reason for the lacklustre Couch Potato performance might be choosing the wrong context. Perhaps another is the fact that “Couch Potato investors accept market returns, minus only small costs.” Within that premise is the expectation that markets will provide a pretty good return. I gather that 4% is less than expected, and I would personally like to see it higher relative to the risks inherent in stocks.

Perhaps it’s because I learned about investing outside traditional channels, but I’ve never been able to swallow the idea that I should be aiming for “market returns” or even that I should try to beat the market. The market is not my benchmark. My benchmark is zero. The further from zero I can get on the plus side, the better I’m doing. If the market return is -6% and mine is -4%, I’m not going to celebrate.

And yes, I’m willing to accept more moderate rewards in return for lower risk. The goal of investing, at least for me, is not to meet or beat the market, but to find the right balance between risk and reward. I want to achieve the highest possible reward with the smallest possible risk. There’s nothing easy about that.

Cheetos Aren’t So Healthy

The Money Sense article described the Couch Potato strategy as “the investing equivalent of flopping in front of the TV with a bag of Cheetos.” It’s definitely easier than learning about the stock market and the macroeconomic environment in which we live. On the “easy” metric, the portfolio delivered. The investment returns it generated over the past 10 years, however, were somewhat lower than advertised.

So does this mean we should throw the Couch Potato strategy into the dust bin with all of the other investment fads? Not necessarily. It’s just a reminder that there’s no “easy button” for investing, and there’s more than one way to save for retirement. It’s like those commercials for sugary cereals:  They’re “part of a nutritious breakfast” but if they constitute your entire meal, that’s not so healthy.

You can’t be an ostrich. You still need to use your head. Sitting on the couch with a bag of Cheetos is fine – once in a while. But if that’s your primary modus operandi, you’re probably going to run into trouble at some point.

 Were you surprised by the Couch Potato results? Do you think it’s a good investment strategy?

 

Written by Kim Petch

27 Responses to Why This Is No Market for Couch Potatoes

  1. Great post Kim!

    To your point about historical references, I have another take. The timeframe is everything really; you can spin any data to meet your needs if you pick the appropriate investment window. I’m not saying you did this in your article, rather, I find many financial articles don’t take this bias into account. While I like your point about contexting, (85-year timeframe vs. 25-year timeframe), choosing an investment window to articulate portfolio returns is something writers need to take into consideration when discussing returns. Even avoiding a few high-return investment days on the market is enough to skew data.

    I’m a big fan of Couch Potato investing, in my RRSP in particular, but no doubt many global potatoes got hammered over the last decade or so. This is why diversification is important not in the short-term, but in the long-run since ultimately over a few decades of investing, things will even out in the wash. Most investors can hold stuff for 1 year, let alone 10 or 20 or better still 30 years.

    On being a potato for part of my portfolio anyhow, I don’t mind “market returns” – because my asset allocation is designed to get me at least 4% every year for the next 25 years in my RRSP.

    Also, with the rest of my portfolio (dividend-paying stocks, my goal is not to hammer the market with my stock returns but rather execute the right balance of risk and reward that meets my investment objectives. Too bad many financial articles do not talk about this more – invest to meet your financial needs, not others – do what is right for you. Personal finance and investing is well, personal after all ;)

    • Since you write about finance, you know how hard it can be to write anything that applies to everyone. You’re right. The whole point of personal finance is to find something that works for you.

      I think Couch Potato investing will be a great strategy once the next secular bull begins. Since no one knows precisely when that will be, it’s not easy to pin down the right time to execute the strategy. If you’re under 30, you’re probably OK gradually adding to a Potato portfolio over the rest of your investing lifetime. Just realize that there will be ups and downs and that no one knows what your final average annual return will be.

      If you’re over 30, you might consider a smaller Potato position as part of your overall portfolio. Again, there’s no one size fits all solution. The point is to do the work needed to find what’s best for you. You put it best: “invest to meet your financial needs”

      Thanks for your comments Mark! :)

  2. Go 2 Cents! Your post reads better than a lot of what I have read from various economists, lately. Not that I am advocating people take your advice, but refusing to consider what it means for them would be, in my opinion, a big mistake. Since I have always felt Buy & Hold was really a marketing, rather than an investing strategy (having worked a number of years in Financial Services), I can’t adopt the Couch Potato approach for myself. Still, having a plan is better than not having one. That said, given the massive demographic change we are about to experience, I am not willing to bet my future on a theory that says the market has to continue making new highs during the majority of the years available to me in which I might earn a return in the stock market. The false belief that the U.S. housing market could only go higher is what convinced too many people there, and a good number around the world, to put their life savings in harm’s way. Even though the “experts” may have known otherwise, that is not what they were telling and selling unsuspecting customers.

    • Thank you Ian. For the record, I wouldn’t want anyone to follow my advice either. I try not to give explicit advice, but just to put information out there that people may not have considered.

      I think a lot of buy & hold info is about marketing, but I know that quite a few people really believe it’s the best way to invest. My aim is to get them to look at both sides and find a compromise that fits their goals and risk tolerance. I think the risks of investing in both bonds and equities are often vastly understated and frequently misunderstood.

      I hope there are a lot fewer “unsuspecting customers” when the next financial crisis hits. Educating investors about the choices available to them has not been a strong suit of the financial services industry.

      Thanks for your comments! :)

  3. Great post!

    If the risks for investing in bonds and stocks are understated, and with the returns for investments in GICs being less than the real inflation rate, what other investment vehicles are available to people saving for retirement? Gold? Real Estate?

    • Gold has been working great, but I’m not sure I want to buy it at $1600. We have the bulk of our savings in GICs at the moment. I know that real returns on some of them are very low. But given the risks in the markets right now, -1% to +3% sounds more appealing than larger losses.

      There are lots of different ways to invest and I’ll try to write about a few alternatives in a future post, but the best way to manage risk is to manage your exposure. Smaller positions work better when uncertainty rises.

      Thanks for stopping by! :)

  4. Good article. There is much ‘doom and gloom’ being reported in the last few months, and no one really knows what will happen in the next 6 months. For my peace-of-mind, I just moved OUT of XIU into XCB. I want to worry less, and relax more this summer!

    • Interesting move. I’ve often thought of investing in corporate bonds as a good way to capitalize on the success of corporations without the higher risk in equities. The monthly distribution doesn’t hurt either. ;)

      Not a bad idea to see how things play out in the U.S. and Europe over the summer and go at it again with a fresh set of eyes in September. Thanks for sharing your idea and I hope you find that peace of mind this summer!

  5. I never liked the idea of benign neglect when it comes to your investments. Sure, I’m more of a buy-and-hold proponent, but I’m still monitoring my investments and following trends.

    As for the time frame, if everyone just looked at the 85 year window then nobody would invest in bonds or GIC’s, since the return from stocks far surpass other investments. But since we deal with 25-40 year investment windows we need to ensure we have an appropriate asset mix for our own situation. I would hate to buy an index fund at the wrong time and watch it return nothing in a bear market.

    • You basically summed up the point I was trying to get at perfectly! I guess it’s that “benign neglect” feel that I object to the most. Investing just isn’t that easy.

      Thanks Echo!

  6. You’re a treasure, Two Cents. Too few bloggers possess the courage to point out the dangers of Lazy Portfolios.

    That said, there is a crying need for this sort of thing. We entered a new world when we made middle-class people responsible for financing their own retirements. We now have millions of people investing in stocks who possess little desire or ability to learn how stocks work. That’s a dangerous combination.

    My take is that we need a modified approach to Coach Potato Investing.

    What we need to do is to lift the Social Taboo that now applies to pointing out to people the times when Coach Potato Investing becomes dangerous. As you point out, there are times when it works well and there are times when it is a disaster. We need to tell people that, clearly and firmly and without apology.

    There’s never in the history of the U.S. market been a time when investors bought stocks that were fairly priced and did not obtain a super long-term return. And there’s never been a time in the history of the U.S. market when investors bought stocks that were insanely priced and did not endure gruesome losses. Why not just let people know that? Then people can invest in Coach Potato fashion without having to worry about seeing their retirements fail as a result.

    Simple is good. It’s simple plus deception that is causing all the trouble. To not let people that valuations matter is deceptive.

    Rob

    • You know Rob, one of the great things about blogging is that it doesn’t pay enough to make me worry too much about toeing any particular party line. Besides, my constitution dictates that I probably couldn’t do that even if I wanted to. (Maybe that’s why I’m not rich! ;))

      Your point about the novelty of DIY investing is a great one. A lot of people 40 and under don’t realize that investing in the markets wasn’t standard before the advent of mutual funds. It’s great for the “average” person to have access to the public markets, but investing is not as easy as the investment industry sometimes makes it sound.

      Buying and holding is great – as long as you buy value. Buying and holding overvalued equities or any other asset doesn’t seem like a great idea. Thanks for continuing to remind us of that fact and thanks for sharing your thoughts here.

  7. I’ve enjoyed deploying bonds as my secret weapons when markets crash–then greedily buying stock indexes with the proceeds.

    As for the couch potato, here’s the interesting part. Few people have the nerve to follow such a strategy. Don’t get me wrong: I’m a firm believer in it. But it asks people to be fearful when others are greedy and greedy when others are fearful. And very few people can do that. Too many people try making decisions based on where they think the economy is headed, and the vast majority of market timers don’t do very well. When there’s blood in the streets, and the economy is screaming Uncle, they don’t want to buy stocks. And when the economy has a rosy consensus, and things are getting more expensive, they feel better about paying higher prices.

    As for couch potato investing, I don’t think many people can do it over a lifetime. I think it would be great if they could, but I’m not so sure they can. As popular as it has become, online, I would bet that very few people will be able to follow the method for long. Psychologically, it’s tough. There are plenty of people who started their serious investing very recently and they will never know how they react to market declines until they hit them, mentally, between the eyes.

    The couch potato returns (4% as an average return over the past decade) is paltry compared to the returns of someone who bought the lagging index over the past ten years, and rebalanced manually when things got really screwy (September 2001; 2002/2003; 2008/2009). Profits made by people who thought dispassionately and rebalanced in such a way (while buying the lagging index each month) made a heck of a lot more than 4% annually. I know that I made more than double that annual return over the last decade, by purchasing laggards and rebalancing when things got screwy. (Yeah, everyone online probably says that, I know) But then, how many people had the guts to do that? A true believer in the method would have done it. But most of those who tout this method or the basic couch potato method, would have crumpled, I believe, making far less than 4% annually, never mind more.

    But if someone with discipline sticks to an allocation of stock and bond indexes, they will be buying bonds when markets rise, and stocks when markets fall. Manually rebalancing when things get way out of whack is a way to beat the vast majority of investment professionals over a lifetime. During volatile markets, it’s a way to make a killing. During bull markets, the bond component adds a drag to the performance. But I can live with the slight drag, when it occurs. After 22 years of dispassionate investing, I don’t mind thinking about protecting some of it now (I have 41% in bonds, and will continue to buy the lagging index, while having a bond index proportionately close to my age) The markets have certainly given me far greater rewards than I ever would have realized, 22 years ago.

    I certainly feel fortunate.

    • It sounds like your version of the Couch Potato strategy takes valuation into account. You’re buying when others are selling. To me, that’s not really a strict Potato strategy, which advocates rebalancing once a year regardless of valuations.

      I would personally prefer your way, but to each their own.

      Thanks for sharing your experiences Andrew! :)

  8. While the post reads well, it’s long on speculation and conjecture, and short on fact. For example:

    >>but secular cycles that last 15-20 years can have a meaningful impact on your portfolio.

    Any data to support that?

    We can ‘logic’ our way around all we like, but the numbers have shown repeatedly that the indexes, the lazy approach, outperforms 97% of every other strategy – over a long period of time.

    For example, I’m sure we can all agree that the markets are low right now. What are we supposed to do when the markets are low? Not wait until they recover. The academics have shown that the markets will typically recover in 2 or 3 one-day recoveries, NOT gradually. So you have to sit out these low periods because if you don’t you miss the recovery. You’ll by buying back in after the markets have recovered, and you’re back to selling low and buying high.

    As for 15-20 year timeframes, there’s a fallacy that the investment timeframe for most people is when they start saving until they’re 65. If you’re 65, how much longer do you have to invest? Probably another 30 years? Sounds like a long timeframe to me. Nothing happens at 65 – our investment timeframe isn’t from when we start to 65; it’s from when we start to closer to age 90. And again that’s a long enough timeframe that the indexes will outperform 97% of everything else over that timeframe – including the people that call this lazy investing.

    • There’s tons of data to support the idea that secular cycles and sequence of returns have a marked impact on your retirement savings. For starters, you can look at anything by Ed Easterling at Crestmont research.

      It looks like the numbers you’re looking at are different than the ones I am. The markets are not “low” right now. They are are only a few percentage points away from recent highs and PE ratios are not at historically low levels: http://www.johnmauldin.com/outsidethebox/converging-on-the-horizon

      When I spoke of 15-25 year time frames I was assuming most people do the bulk of their saving between the ages of 35 and 60 – not that they would begin at 65. I would hope that most people have finished saving by 65 and are enjoying the fruits of their life’s work. Why risk that you’ll lose that money in a bear market?

      There’s nothing wrong with index investing, but blindly following the advice of those who have a vested interest in keeping all of your money in the stock market until you’re 90 is something we need to be really careful about. Investment returns will depend on how you allocate your assets: are you going to put 75%, 50%, or 20% in equities? For how long? The risk levels are a lot different for each. When you invest is important too. Buying when valuations are high is going to be a losing proposition.

      Thanks for your comments.

  9. I may be a very novice investor, but I’m afraid I don’t understand the point of your article. It seems to be saying that Couch Potato strategies aren’t good, or are at least not optimal, but there doesn’t seem to be a better alternative presented. The closest reference to that I saw was:

    “But it’s not much better what you could have achieved with a CDIC-backed 5-year GIC ladder.”

    Doesn’t that imply that it was a little better, despite everything else doing poorly? What’s wrong with that?

    Is there something else that people should be doing instead, or in addition to Couch Potato investing?

    I really just don’t see where you’re going with this.

    • The point is not necessarily that Couch Potato Investing is a bad strategy, but that we need to be careful about using one-size-fits-all appproaches. Putting all of your money into this approach and expecting annual returns of 6%-8% like clockwork isn’t realistic – especially in a secular bear market.

      It’s not that there is no alternative to CP investing, but that there are so many alternatives that will work just as well or better – too many to include in a single article. No strategy offers predictable returns.

      The point of the article is that no matter which investment approach you take, you can’t predict your returns in advance – and investing is not as easy as some of the Couch Potato proponents make it sound.

      Thanks for your questions Jeremy. :)

  10. The next 20 years are going to be prime investing years for me… if stock prices go down! I know I’ll be putting in much more in the future that I have now so declining prices would be a bonus. Echoing My Own Advisor above, my financial plan is built on a 5% real return so I’m not depending on a lucky result. I’ve already paid a high price for a house and a CPP increase might pass eventually, so hopefully those boomers won’t sell us overpriced stocks too :)

    Taken in the abstract, getting the index return doesn’t mean anything since it varies so widely. But it does still have some value in that it’s a return anyone can get with little work and without “making an investment” involving an envelope full of cash and a dark alley. In that sense it’s comparable to GICs. They are rarely the best choice but they do make money and have no barriers to entry and few risks.

    • I like the way you framed your discussion. For someone with a 20 year plus time frame who doesn’t already have a lot invested in the markets, gradually committing capital when valuations come in is a good plan.

      I like the low fees of the Couch Potato strategy. I just think it would work better with some kind of valuation component where you buy when valuations dip rather than based on the calendar. I think it could add more return for relatively little effort – especially in the current investment climate.

      Thanks for sharing your thoughts Value Indexer! :)

      • I want to do something like what you describe but I’m taking the long-term plan and making small adjustments when I think it’s right instead of staying out entirely until everything is perfect. If most investors behave in an instinctive way and lose money, it stands to reason that going the opposite way might make you the one they lose it to :) But there’s a lot of false signals and feedback loops so by avoiding slightly overvalued markets you may actually give up a fair portion of the long-term return. And with undervalued markets it’s “the market can stay irrational longer than you can stay solvent”.

        If investment returns are a reward for risk at least there’s a lot of opportunities for reward now!

  11. You said:

    There’s tons of data to support the idea that secular cycles and sequence of returns have a marked impact on your retirement savings. For starters, you can look at anything by Ed Easterling at Crestmont research.

    Yeah – but you’re completely missing the point. There’s even more data that shows that YOU CAN”T BEAT THE MARKETS OVER THE LONG TERM. (capped for emphasis). Surely you know that market timing – which is what you’re inferring here – does not outperform passive index investing. That has been proven statistically, repeatedly.

    Secular cycles have impacts. But the implication that therefore trying to beat these cycles will improve your earnings has been shown to be false.

    Secondly, in terms of the ‘to age 65′ timeframe, perhaps I wasn’t clear with my point. The investing timeframe for most of us is not 30’is to 65. It’s 30’is to 90. Someone at 65 still has a 30 year investing timelime – and that’s longterm by any stretch. The idea that someone at 65 becomes someone with a ‘conservative, short investment timeline’ is a myth. A 65 year old person still needs to be investing for the longterm – and that implies equities.

    You said:
    Putting all of your money into this approach and expecting annual returns of 6%-8% like clockwork isn’t realistic – especially in a secular bear market.

    Of course it’s realistic. Again, you’re throwing in market timing. Expecting 6-8% ***over the long term*** is absolutely fine with equities. that’s the entire point behind passive investing. You’ll get those rates of return as long as you ignore advice to start doing market timing. Those that DO start doing market timing, thinking they can outhink the market and earn more money short term, well again it’s been shown repeatedly that 97% of the time those people fail to outperform the index over the long term.

    • Again, my goal is not to “outperform the market”. It’s to gain the best return possible without losing money. As for the data, I’ve seen the passive investing propaganda and I do understand where they’re coming from. But there’s just as much data to refute much of that research. Without a specific study in front of me, it’s difficult to address generalities. There are plenty of people who do fine investing actively, or even less passively, or without equities. The fact that academics have failed to document their progress does not negate that reality.

      I know there are folks out there who are absolutely evangelical about passive investing. (The fact that many are in the financial services industry should raise red flags for the average investor.) I understand that the average investor won’t do well day trading or swing trading – at least not without some education and experience. But I don’t think telling everyone that there’s only one way to invest and that they can expect a given return in any time period is accurate. If there are any passive investors out there that will let me invest my money for the next 30 years with a guaranteed 8% return whereby they will make up the difference if it doesn’t work out, I’d be very surprised.

      I still completely disagree with the idea that a 65 year old should take the same approach to investing as a 35 year old. Once you lose the ability to make up for investment losses with earned income, you’re at a different level of risk. Further, each person’s situation is different and must be taken into consideration. Perhaps a multimillionaire can afford more market risk. Someone who saved their whole life to have just enough to retire is in a completely different boat. Markets can and do go down. When that happens relative to your life cycle is extremely relevant.

      Timing the market is what every investor does whether they want to admit it or not. When you buy something, you are betting it will rise by the time you need to sell it – whether that’s 10 minutes or 10 years from now. Buying anything without regard to time and price doesn’t appeal to me, nor do I think it’s a wise way to purchase any product. If others want to invest that way, that’s their prerogative. Claiming it’s the right way or the only way is more than debatable – as we’ve shown by our discussion here.

      Thanks for the reply Glenn!

  12. I’ve been reading books and articles like mad to learn how to be an investor. The couch potato strategy seemed for a short time to be the easiest to comprehend. It seemed rational. But now, with what’s been happening in the world lately, I don’t understand how anyone would want to put a single dollar into the great casino called the stock market. It’s like the people who have their money and emotions invested in the way things usually work can’t see the obvious right in front of them. To me it’s obvious, because I’m unattached. Everything is crashing down around us, hard times ahead for most people. Perhaps VERY hard. The United States has gutted itself financially. Laws and legislation put in place since 2001 have stolen the most basic rights from the people living there. It brazenly, arrogantly invades one country after another on behalf of the corporations that own it. An Orwellian surveillance system is being constructed and the masses are so asleep they hardly think it matters. Canada is all to happy to go along for the ride. It’s the same in EVERY western country, it’s all happening at the same time. This cannot end well.

    My one and only comfort is that the gold I bought in 2008 has more than doubled in price, with no end in sight! China recently opened a gold exchange and encourages its citizens to invest. Central banks all over the world are purchasing large quantities for self protection. It may seem expensive now, but it’s not going to drop in price for a while yet. Same goes for silver. Don’t let the business guys on TV scare you away from something so simple and straightforward. Couch potatoes, turn off your TVs and stand up!

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