Couch Potato Investing is a popular investment strategy that does not require good financial investment knowledge. It was developed in 1991 by the famous financier Scott Bernst as an alternative to people who were paying separate specialists to manage their investments.
Canadian couch potato is a passive strategy and is more suitable for investors who count on a long-term perspective and are not ready to observe the state of the stock market. If you are more interested in watching and reacting to the situation on investment platforms, this approach will definitely not interest you. What is a couch potato investment strategy and how it works – let’s figure it out in this article.
Creating a Couch Potato Investing Portfolio
Couch Potato Investing’s portfolio requires minimal maintenance and time to set up and low cost. The essence of the strategy is to divide your assets equally between stocks and bonds. Because investing in bonds involves a more conservative approach than in the case of stocks. The strategy increases their value by reducing portfolio volatility at a low cost and with minimal investor effort.
When creating a homegrown portfolio, an investor puts half his or her money in a common stock fund and the other half in an intermediate bond fund. The former can track a market such as the S&P 500 Index, the latter the Bloomberg US Aggregate Bond Index. Financier Bernst also suggested two additional investment funds that correlate with the asset classes described: the VSBSX short-term fixed-income government bond fund and the VFIAX fund. You don’t have to use the proposed funds, there are plenty of others.
Investors need to divide the total value of the portfolio into two halves at the beginning of the year. Then balance the portfolio by putting one half of the money in stocks and the other half in bonds. There are no clear rules for dividing assets. You can choose an 80/20 ratio if you decide to give more preference to bonds or stocks. But most couch investors invest in equal portions, 50/50.
Once you’ve decided how to divide your portfolio, you can start buying stocks and bonds. This may be the easiest step in building a couch portfolio if index mutual funds or exchange-traded funds (ETFs) are chosen.
In the future, you will only need to log into your brokerage account once a year to see how your funds perform and how your portfolio is weighted. This is where you can adjust your allocation of funds anew. For example, put the bulk of it into bond investments. That way you can keep your target allocations on both securities.
What are index mutual funds?
To understand what is a couch potato investing, you should understand what index mutual funds are. The essence of them is that fund managers collect investors’ money, put it into a large pool and channel it into different areas, assets and strategies. Index funds are usually created by financial managers who put together a portfolio of stocks that tracks a particular stock index. For example, the S&P 500.
If the fund manager performs his or her duties well, theoretically the stock price of the index fund should move in parallel with the stock market index he or she is trying to mimic, but in reality that is not always the case. The fund manager is only trying to track or match the stock market index. He does not choose at his discretion the best stocks for a mutual fund.
Index funds give investors the opportunity to invest in an unlimited number of stocks in a single purchase. But keep in mind that about 1% of your investment will be withheld to pay the fund’s commission. It’s important to understand that a diversification portfolio can help spread your risk, but it can’t guarantee profits and possible losses during market crises.
What is a stock fund?
An exchange-traded fund is a basket of securities that allows you to track an underlying index, so there’s no need to invest in individual stocks. Today there are different versions of ETFs, which differ by area of the economy, region, and other categories. Investors have the option of investing in ETFs that track commodities, currencies, and bonds.
Asset allocation and ETFs
When it comes to asset allocation, management expense ratios matter a lot. If you want to maximize your returns, costs are important to consider, especially if your portfolio is not yet large. ETFs imply lower management fees. In addition to the commission, you need to consider transaction costs. They are much higher in EFTs than in mutual funds. However, in this case, the annual maintenance fee is lower.
Couch Potato Investing will probably limit you to a few balanced index funds, but at the same time you can maintain low-cost diversification if you choose the right fund. Investors have the option of building a portfolio with ETFs that feature a wide variety of assets and low costs. BMO, Vanguard and iShares are considered leading ETF providers. You can also access ETFs through an online broker.
You can go beyond simple fundamentals and choose ETFs that target specific categories of stocks and bonds. For example, large-cap or small-cap companies, dividend- or non-dividend-paying organizations, corporate or government bonds, etc.
Couch potato asset allocation ETFs can help create a balanced low-cost portfolio. Compared to individual ETFs consisting of a specific set of stocks and bonds, an asset allocation ETF is considered more expensive and less flexible. Either way, the work of balancing securities is done for you.
Vanguard and iShares offer balanced ETF portfolios of 20%, 40%, 60% and 80% stocks. Investors have the option of choosing the best fit. Both companies also have an ETF that includes only stocks. But it can be combined with bonds in the proportion you choose.
What are the differences between index mutual funds and ETFs?
Both funds are very similar, but they also have significant differences. For example, ETF prices can change throughout the day in real time, allowing for complex order types. Index mutual funds are usually priced at the end of the trading day. They may be actively managed by a portfolio manager, which implies a high service fee.
ETFs often passively track the movement of a security or index with minimal human intervention, so the investor does not have to pay large fees. ETFs are also considered more tax efficient than index mutual funds. In addition, they can provide access to certain market niches that are not always available with index mutual funds.
Overview of couch potato investing: benefits
Couch potato investing won’t appeal to every investor, but there are a number of reasons why this strategy can be beneficial. The main advantages include:
- Low cost. ETFs and index mutual funds don’t require active monitoring and management, so you don’t have to pay large sums to a portfolio manager. Typically, service fees do not exceed 1% of your investment amount.
- Diversification. A domoxed portfolio usually includes ETFs and mutual index funds, which provide access to a wide variety of securities. From a mutual fund, you can expect your portfolio to mimic the performance of a well-known index, most of which include hundreds of stocks. Diversifying your portfolio with fixed-income bonds and stocks will allow you to hedge against losses during market downturns.
- Risk. Another benefit of a couch portfolio is reduced investment risk. Mutual funds and ETFs allow you to intelligently diversify your funds, which to some extent reduces your exposure to losses. At the same time, high returns on your portfolio are also not guaranteed.
- Security. An ETF is as safe as the securities it contains. However, some highly diversified ETFs are safer than individual stocks, provided you hold them for a long time. On its own, an ETF is a safe tool, as long as your investment horizon is at least five years. If you need money from investing faster, invest less in ETFs.
Disadvantages of ETFs
All investment funds involve a certain amount of risk. ETFs are no exception. Although it can be used to intelligently diversify your portfolio, they are not always diverse. In some cases, an ETF is limited to a specific industry or region. Experienced investors are advised to find out in advance what the ETF you intend to invest in consists of.
Also, ETFs don’t always come cheap. In any case, you will have to pay a manager to manage the portfolio. Compare the costs of an ETF – sometimes they are much higher than the costs of a traditional index fund. This will allow you to make the right choice for investing your money.
Couch Potato Investing: Conclusion
Canadian couch potato investing allows you to take a “set it and forget it” approach to building a portfolio. This strategy will require minimal of your attention and expense. Couch potato investing is great for you if you want to grow your portfolio but don’t have the free time. Despite the benefits of lazy investing, you will still need to weigh the cost and effectiveness of the strategy against your financial goals.
If you don’t have enough knowledge of investment programs, you have the option of contacting a knowledgeable financial advisor who can advise you on how to proceed in any given case and point you to the best funds to invest in. In order not to lose money and not to find yourself in an unpleasant situation, treat the choice of manager global couch potato responsibly and carefully.