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

~Raymond E. Feist

Couch Potato PortfolioA 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?