Maintaining a diversified portfolio of thoughtfully chosen assets is the key to building wealth over time in the stock market. While diversification may seem difficult, there’s a category of portfolios known as “lazy portfolios” that aim to simplify the process.
The laziest of the lazy investment portfolios is known as the Scott Burns Couch Potato Portfolio. The portfolio was designed to give investors the ability to participate in the stock market safely with no more than 10 minutes per year dedicated to the process.
Although that may sound like it goes against everything you’ve learned about carefully managing investments, surprisingly, since its creation in 1991 the portfolio has been a solid performer, reducing drawdowns during bear markets and providing meaningful long-term gains.
What Is the Scott Burns Couch Potato Portfolio?
The Couch Potato is the ultimate in portfolio simplicity, consisting of only two assets, yet it’s built for protection via diversification of both assets and asset classes.
How’s that possible?
Scott Burns — personal finance columnist for the Dallas Morning News, founder of AssetBuilder.com, and creator of the Couch Potato strategy — uses a process known as indexing. Indexing means investing in highly diversified index funds in order to protect yourself while also simplifying your portfolio.
At its core, the Couch Potato includes one exchange-traded fund (ETF) that tracks an underlying stock index and one bond fund. The investment in the ETF gives the investor exposure to the overall market or a large portion of it because index funds are designed to track large swaths of the stock market.
The bond fund, traditionally a U.S. Treasury fund, is used to protect against volatility in the event of declines in stocks.
When the right funds are chosen, the portfolio does exactly what Burns wanted it to do, providing highly diversified exposure to the gains the stock market has to offer while offering stability through safe fixed-income investments.
The portfolio is said to be so simple to manage, it takes less time per year than it would take to microwave a single medium-sized potato.
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Portfolio Asset Allocation
As mentioned above, the portfolio is built of only two assets, both of which are investment-grade funds. Traditionally, the recommended investments include equal investments in the following:
- Vanguard Total Stock Market ETF (VTI). This fund is designed to track the returns of the entire United States stock market, including all sectors and market caps. This portion of the portfolio gives you highly diversified exposure to the equities market — the source of the majority of gains experienced within the portfolio.
- iShares U.S. Treasury Bond ETF (GOVT). The GOVT fund is designed to track returns of the entire U.S. Treasury Bond market. The fund invests in a wide range of Treasury securities with maturity dates ranging from one to 30 years. The investment in Treasury bonds provides a stable foundation should the bottom fall out of the stock market.
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The Investment Thesis Behind the Portfolio
The thesis behind the Couch Potato is the idea that investing doesn’t have to be difficult. Over time, opportunities have become available to simplify the investing process to the extreme, and that’s exactly what this portfolio has to offer.
As you could imagine, with only two assets to move around, the portfolio can be customized easily. However, Burns suggests that any rendition of the portfolio keep the following core tenets in mind:
- Diversification Is Important. The point of indexing is to gain access to a large list of diversified assets with a single purchase. If you decide to trade one fund in the portfolio for another, make sure that the fund comes with a heavily diversified portfolio, which acts as insurance against volatility.
- Low Costs Are a Must. Investing in investment-grade funds greatly reduces your costs. If you decide to switch these funds for other opportunities, it’s important to pay close attention to expense ratios, making sure that your expenses are far lower than industry averages.
- Keep It Simple. If you’re following Burns’ Couch Potato model, simplicity is key. It’s perfectly fine to trade one asset for another, but don’t muddy the waters by adding to the total number of assets. Simply keep the asset count to two — one that offers diversified exposure to stocks and another that offers diversified exposure to fixed-income securities.
Portfolio Pros & Cons
As with any other prebuilt portfolio, the Couch Potato comes with its own list of benefits and drawbacks. Before diving into this portfolio, investors should consider the following:
Couch Potato Portfolio Pros
There are plenty of significant benefits to the Couch Potato strategy, all of which are centered around Burns’ main goal of simplifying the investing process. Here’s what investors enjoy:
- Easy Management. Most investing strategies require quite a bit of research before choosing assets and frequent rebalancing. Not the Couch Potato strategy. The hands-off approach makes this option appealing for busy investors or those who don’t have a detailed understanding of what makes the market tick.
- A Safe Bet. With 50% of the asset allocation in the portfolio being geared toward fixed-income securities issued by the U.S. government, the portfolio is a pretty safe bet. In fact, throughout its history, drawdowns during market corrections and recessions have been minimal when compared to the S&P 500.
- Reasonable Returns. With such a large portion of the portfolio being invested in Treasury securities, one would expect returns to be significantly lower than market benchmarks. However, using the traditional asset allocation described above, the portfolio has performed only slightly lower than the average S&P 500 returns over the long term. Couch Potato investors aren’t giving up much in terms of return for the added safety offered by such a strong fixed-income allocation.
Couch Potato Portfolio Cons
While the portfolio is one of the easiest ways to get involved in the market, there are some drawbacks to taking the easy way out. Here are the cons you should consider:
- Allocation Issues. Most financial advisors suggest investors should change their allocation strategy as they age, with higher percentages allocated to stocks in their younger years and larger allocations to bonds as retirement nears. Following a strict 50-50 allocation strategy could leave you underexposed to potential gains or overexposed to potential risks, depending on your goals as an investor.
- Limited Returns. With this portfolio, your performance will be similar to — generally slightly below — the performance of the S&P 500, if history is any indication. Your chances of beating the market are essentially zero. While it’s a great portfolio for investors with a limited risk appetite, it’s not a good fit for those looking to accept a little risk in exchange for market-leading performance potential.
Who Should Take Advantage of the Couch Potato Strategy?
The Couch Potato strategy isn’t a one-size-fits-all approach; no strategy is. Those who would be the perfect candidates to become Couch Potato investors include:
- Investors With Little Time. The Couch Potato Portfolio is one of the simplest portfolio strategies, requiring very little time for setup and management. As a result, if you’re an investor who simply doesn’t have the time or desire to do in-depth research, this strategy may be a perfect fit for you.
- Investors With Low Risk Appetites. The traditional Couch Potato Portfolio was designed to minimize risk, resulting in less time managing the portfolio. However, any low-risk portfolio generally comes with limited returns, as is the case with the Couch Potato.
- Retirement Investors. If you have long-term investment goals, such as retirement, a slow-and-steady approach is often a great way to go. That’s the exact approach the Couch Potato was built around.
How to Customize the Couch Potato to Fit Your Needs
While the traditional Couch Potato Portfolio is focused on investing in the market as a whole without a focus on specific strategies or increased risk levels, the portfolio is also heavily customizable, making it possible to fit the needs of a larger group of investors.
The Couch Potato for Growth Investors
If you’re a growth investor who wants to take a more simplistic approach to the investing process, you can adjust the Couch Potato Portfolio, trading out the VTI fund for the Vanguard Growth Index Fund ETF (VUG).
The VUG fund tracks the CRSP Large Cap Growth Index, which is a group of large-cap stocks that have both a history of growth in revenue and earnings and an expectation that their growth will continue.
Consistent with the thesis behind the Couch Potato model, the fund is highly diversified and comes with industry-low expenses, with an expense ratio of just 0.04%.
The Couch Potato for Income Investors
If you’re more interested in income than growth or value, you may be able to achieve your goals by trading the VTI fund for the Vanguard High Dividend Yield Index Fund ETF (VYM). The fund tracks the FTSE High Dividend Yield Index, made up of stocks that are known for producing dividends at a higher rate than their peers.
As a highly diversified index, investments vary across various sectors of the market. Not to mention, with an annual cost of just 0.06%, the fees associated with the fund are highly competitive.
The Couch Potato for Value Investors
If you’re looking for value investing opportunities, you can switch the VTI fund out for the Vanguard Value Index Fund ETF (VTV). The fund tracks the results of the CRSP U.S. Large Cap Value Index, which is made up of large-cap domestic companies that display strong value characteristics.
As with other funds mentioned here, the VTV fund is highly diversified, offering exposure to various sectors of the market. The fund also has an expense ratio of just 0.04%, far below the current industry average of 0.44%.
The International Couch Potato
International stocks have a history of producing compelling returns, and there are plenty of investors who want to include them. If you’d like exposure to international opportunities, simply trade the VTI portion of the portfolio for the Vanguard Total World Stock Index Fund ETF (VT).
One of the most diversified funds on the market, the VT fund offers exposure to the overall market both in the United States and abroad. Moreover, the annual cost associated with the fund is just 0.08%, in keeping with the low-cost tradition of the Couch Potato strategy.
The Moderate-Risk Couch Potato
If you’re interested in a medium-risk profile in exchange for the potential for increased profitability, simply trade the VTI fund for the Vanguard Small-Cap Index Fund ETF (VB). The fund is made up of small-cap stocks, which offer some of the highest potential growth compared to larger market capitalization peers but come with increased risk.
Nonetheless, this increased risk is heavily offset by the 50% allocation to Treasury securities, giving the overall portfolio a medium risk.
The High-Risk Couch Potato
Finally, the high-risk Couch Potato takes a bit of moving around.
First, your stock allocation would again be pointed toward the VB fund of small-cap stocks, offering higher potential for growth than investments in the overall market as a whole.
On the safe-haven side of the portfolio, you would invest in real estate, either directly or through a real estate investment trust (REIT). Real estate investments are all about income, and while they are not fixed income, they offer a higher-risk, higher-returning alternative to low-risk bonds.
Keep in mind that this is a very high-risk portfolio structure and should only be used during bull markets by investors with the highest appetite for risk. However, if you’re looking for the largest growth potential in a Couch Potato-style portfolio, this is the setup you’re looking for.
Keep Your Portfolio Balanced
The basic concept surrounding the Couch Potato Portfolio is that by keeping investments balanced evenly between stocks and bonds, you’ll maintain a portfolio that has the potential to yield meaningful returns while maintaining stability.
While there is little work involved in managing the portfolio, there’s a difference between little and none.
Burns suggests that you only need to rebalance your portfolio once per year, and given the safety aspects of the portfolio, that makes sense. However, with only two assets involved in the portfolio, rebalancing is fast and worth doing at least on a quarterly basis.
The good news is that rebalancing is as simple as dividing a number by two. Simply divide your entire portfolio value by two to get the amount of money you should have evenly invested into stocks and bonds. If the portfolio falls out of balance, simply take from one asset class and give the excess to the other to create the balance needed.
All in all, the Couch Potato Portfolio is a great way to go for investors with little time or desire to research markets or individual stocks. It provides exposure to the market in one of the safest ways possible.
On the other hand, the heavy allocation to Treasury securities greatly limits your earnings potential. As a result, the portfolio isn’t suited for everyone.
While adjustments can be made to the portfolio, you’re limited to only two assets, with the safer side of your portfolio always representing 50% of its overall value. As a result, your chance of beating market returns is minimal.
However, if you’re interested in taking a slow-and-steady, hands-off approach to investing, the Couch Potato is a great portfolio strategy to follow.