Some of you may be wondering what a Couch Potato Portfolio might be. The concept was created by Scott Burns the past personal finance columnist of the Dallas Morning News. He came up with the passive investing strategy of purchasing index funds, often referred to as Indexing.
The original strategy involved investing half of your money in an S & P Index fund and half in a fund mirroring the Shearson/Lehman Intermediate Bond Index. Burns used the Vanguard 500 Index and the Vanguard Total Bond Fund Index.
If you had a higher risk tolerance you could modify the 50/50 asset allocation strategy to 25% in the Vanguard Total Bond Fund Index and 75% in the Vanguard S & P 500 Index. This 25/75 allocation is known as the “Sophisticated couch-potato portfolio.
By using this strategy, you eliminate the expense of a broker or advisor and reduce the investment expenses since you are buying index funds that are not actively managed.
The theory behind the Couch Potato Portfolio is you reduce your investment costs, you buy index funds and hold them indefinitely, and re-allocate the 50/50 or 25/75 allocation quarterly or annually. Thus, there is little effort, no active management, you sit on the couch, be a potato, and let the account grow. Seems pretty simple doesn’t it.
The passive management style such as the Couch Potato Portfolio is fine and well when there are no major long term storms ahead. You can kick back, relax and not worry.
But what will the purveyors of the Couch Potato do when they see a prolong downturn in bond values and their bond index fund?
In my last blog The Risk of Owning a Bond Fund When Interest Rates Increase I explain how bond mutual funds and bond exchange traded funds will have prolong losses. These losses will continue for many years as interest rates slowly increase.
In the last quarter of 2016 we had a mere one quarter of a percent increase in Fed Funds interest rates. That resulted in losses of 3 to 4.5% in most bond funds. This has continued in 2017 with three more Fed Fund rate increases.
The Fed and our new government leadership intends to increase rates again in 2018. Multiply the 3 to 4.5% loss by three and I think you will understand the gravity of the situation.
Look at how much interest rates could increase compared to historical interest rates. If you tried to buy a house in the late 1970s and early 1980s you had the pleasure of paying double digit interest rates. How painful will an increase in interest rates of that magnitude be in comparison to the magnified bond fund losses?
If you multiply the potential one-year loss, as mentioned previously, times a multi-year long term increase, you may begin to grasp the potential losses that many Couch Potato followers will incur.
This is where a broker and or an advisor does provide value. By changing from a bond fund to a portfolio of individual bonds you will not suffer those losses. You will be able to better control your rate of return (not losses) for a minor commission or fee. The commissions paid will be substantially less than the losses you may incur in a bond fund.
You can still diversify your portfolio of bonds. You can control the maturity dates. You can be certain of your future.
In the coming years, Bond Funds, the term bond, may become a four letter word. So will the Couch Potato portfolio. Not to mention the Target Date funds as I wrote about in my previous in the previous blog.
If you have a large position in a bond mutual fund, exchange trade bond fund, or Target Date fund, please contact us so that we may guide you to a less volatile journey.
Corey N. Callaway
Investment Advisor Representative