Are you ready for a Couch Potato portfolio?

January 8 2008 by Ellen Roseman

It’s become popular to say investors can profit by creating a simple portfolio of low-cost index funds traded on a stock exchange. It’s less expensive and easier than buying stocks or actively managed mutual funds.

The latest is Larry MacDonald at Canadian Business with his “one-minute portfolio,” a mix of just two ETFs (large-cap Canadian stocks and bonds).

MacDonald’s portfolio is even simpler than the Couch Potato strategy laid out in Money Sense magazine in March 2006, which includes some U.S. or international equity index funds. If you intend to retire in Canada, you can probably get away with keeping all your investments here.

There’s also the Easy Chair portfolio, developed by Rotman business professor Eric Kirzner and tracked by the Toronto Star’s Portfolio Doctor column. Back in 1997, Kirzner predicted that he could earn a return of about 8 per cent over time on an annual compounded basis. And he was right.

His basic and conservative asset allocation is 20 per cent cash, 30 per cent Canadian bonds, 35 per cent Canadian equity and 15 per cent U.S. equity.

“I picked an asset allocation that is classic,” notes Kirzner. “It is a balanced portfolio and quite defensive. Twenty per cent in cash is quite high but if I was anticipating the year 2000 crash I would have gone 100 per cent in cash!”

So, what’s the appeal? Why not be a “gamer” a la Jim Cramer, constantly buying and selling and following hunches and changing your mind? Isn’t the couch potato diet just like it sounds — bland and starchy?

Well, if you’re not a couch potato yet, here are some reasons to warm up to the idea.

–You’re not paying a manager to lag the index
–You’re not trying to outguess the market
–You’re saving time and emotional energy

Scott Burns, a columnist for the Dallas Morning News, came up with the concept in 1991. He says it’s important to be a dull investor.

This means:

no complicated accounts
no diligent reading of the financial press
no phone calls from brokers with opportunities
no meetings with investment advisors demonstrating their constant supervision of accounts.
and very simple tax returns.
It also means more time at the beach, if you are so inclined. Or more time being a couch potato.

With the stock markets so wild and crazy, a couch potato plan — boring though it may be — starts to look very appealing.

Give us your thoughts on how the lazy approach works for you.

15 comments

  1. bylo

    Jan 8 2008

    http://www.bylo.org/15yr4q06.html

  2. Canadian Capitalist

    Jan 8 2008

    I’ve mostly given up on stock picking and have implemented a lazy approach for most of our portfolio. Apart from the advantages you’ve quoted from Scott Burns, I also find that I hardly ever check up on the indexed investments because there is no tinkering involved.

  3. Not A Day Trader

    Jan 8 2008

    Another factor people often forget is trading fees. Unless the trades are for substantial amounts, the $29 fee per trade can really eat into the returns. On a $1,000 stock buy, it’s the same as taking 3% right off the top.

  4. brad

    Jan 8 2008

    It’s too soon to say how the approach works for me, as I’m still about 20 years away from retirement. However, I’ve been keeping my retirement investments in index funds for nearly 10 years now and intend to keep them there. I’m far enough away from retirement that I don’t mind taking risk, so my investments are nearly 100% in index funds, no cash or bonds. As I get closer to retirement, I’ll shift into less risky investments.

    Basically, though, I subscribe to the “set it and forget it” strategy. Maybe I’m misunderstanding how it all works, but it seems to me that there’s no reason to maximize my gains in the short term when I’m investing for the long term. Any gains I might make this year might be offset by losses next year. What matters is how much money I have when I get close to retirement, and all the evidence I’ve seen is that an index fund is most likely to get you the maximum return over the long haul. I see no compelling reason to do anything different.

    Short-term investing is a different matter entirely. I also, at some point, plan to put some “throwaway” money into riskier investments…if they do well, great; if they don’t, then I won’t feel bad about losing the money.

    But for the bulk of my retirement investment, I keep my money in low-fee index funds and pay little to no attention (for now) to how they’re doing from year to year. We’ll see in 20 years or so whether that was the right approach. ;-)

  5. Ellen Roseman

    Jan 8 2008

    I just wanted to respond to Not A Day Trader about trading costs. Because of an ongoing price war among discount brokers, the standard fee for many people is $9.95 a trade. This isn’t significant unless you’re doing multiple trades each day.

    Today, there’s a new announcement about fees going down, though you have be a hyperactive trader to benefit.

    E*TRADE Canada is introducing flat $6.99 Canadian and U.S. equity commissions for retail customers who conduct 150 or more equity trades per quarter.

    For those with $50,000 in assets and 30 or more equity trades per quarter, you can trade an unlimited amount of shares for a $9.99 flat fee.

  6. bylo

    Jan 8 2008

    Ellen wrote, “the standard fee for many people is $9.95 a trade.”

    That’s true only for those with at least $50,000 at E*Trade and $100,000 at others like TD Waterhouse.

    People who are starting out don’t have that kind of money, nor do they need to spend $30 to buy an ETF. They can create any of the above-mentioned passive portfolios using TD eFunds. These are index funds that have low minimum purchases and low fees (MERs are typically 0.3% to 0.5%).

    You can buy TD eFunds online or via WebBroker if you’re already a TD Waterhouse customer.

  7. squawkfox

    Jan 8 2008

    I opened a TD eFunds account in the summer. I am constantly wondering at what point it makes sense to switch over to ETFs? Or do I switch over at all? I’ve read MANY Couch Potato portfolio recipes…including the one on MoneySense.com, but no where can I locate what to do with index funds once a certain size is reached.

  8. George

    Jan 8 2008

    Squawkfox: If you’re investing regularly (say, when you’re paid biweekly), then index funds make a lot more sense, since you don’t need to pay trading fees to make contributions. If you only invest new money periodically (say once or twice a year), then ETFs make more sense, since you’ll get the benefit of the lower MERs.

    If you’re buying new shares in ETFs regularly, the trading fees will outstrip any savings from the lower MER.

  9. squawkfox

    Jan 9 2008

    George: I’ve been contributing regularly and have amassed a good sum. My regular contributions are indeed why I chose index funds over ETFs a while back.

    Now that I have amassed a “good sum”, is there a point when it makes sense to change my approach since my investment could now benefit from the lower fees offered though ETFs?

    I suppose I just need to do the math to see what my taxes would be if I sold my index funds and bought into ETFs. Also, I would be fine to only contribute a few times in the year, rather than every month. :) It’s amazing how all these contributions have added up over time!

  10. bylo

    Jan 10 2008

    BTW, there are several threads on Financial Webring Forum about the pros and cons of using ETFs, eFunds, etc. to implement couch-potato portfolios.

  11. Jamie

    Apr 11 2008

    I just wanted to add that Questrade also has RSP accounts, and one can trade for $5 a trade there.

  12. Jamie

    Apr 11 2008

    Or, if they want to trade with a cash account, go with Interactive Brokers, which has the lowest commissions in the industry at $1 for 100 shares.

  13. Dave

    Jun 10 2008

    I use a combo of index funds and ETFs. I have my regular contributions go into index funds (no fees to purchase, but higher MERs than ETFs). Then, once a year or so, I sell the index funds and do bulk purchases of ETFs. I also use the oportunity to rebalance. The best of both worlds…

    This, of course, assumes you are contributing to a tax free account, such as an RRSP. I have not done the math to determine if it makes sense to take this approach with a cash account.

  14. Adam

    Jun 19 2008

    @Dave: I am interested in how you buy index funds year round and then sell them to purchase into ETFs once a year. Are you doing this all within the same broker?

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