When Being Lazy Is Effective

Hey guys! Just came back from a Denpasar turnaround, but I'm excited to share the simple investment strategy I've learnt from my many books!

Do you recall the times when you were young and your parents yelled at you for not making your bed, not studying and watching TV all day or not doing your homework? That's not a good way of being a couch potato.

However when it comes to investing in index funds and bonds, sometimes a lazy strategy is a good strategy.

The Couch Potato Strategy (simplified as CPS for this post) is a very simple investment strategy that was made popular by Scott Burns. In very simple terms, it's just investing the same amount of money in  market index funds and bond index funds. I.e to say, half your monthly commitment goes to buying index funds and the other half to bond index funds.

You just do this investment monthly, and at the end of every year you sell whichever is higher and buy whichever is lower to regain the 1:1 ratio of stock : bonds value. That's the gist of it. The CPS strategy works on the advantage of dollar cost averaging. Although it seems that a 50% allocation to bonds is very conservative, however the returns are still great because you have the chance to buy underpriced stock index when you earn from bonds when the market is down.


CPS in Singapore?

I'm only adopting the structure of CPS in a sense that I invest an amount monthly and rebalance my portfolio annually. But because of my age and the government's CPF initiative, my strategy is to go 80% in index funds and 20% in bond index funds. However, the principle is the same. I get to be 'lazy' and only rebalance the ratio to 8:2 once every year.

The allocation of bonds will increase with age, but as a general rule of thumb, individuals who is more afraid of risks should follow:

100 - (age)  to allocate stocks and bonds

while individuals with a little more risk appetite can go for:

110 - (age) to allocate stocks and bonds

I personally would not recommend going fully in stocks. I've ran a portfolio simulation that shows fund performance over 20 years (I'm using US Index Funds and Bonds as an example, but the principle is the same) with 3 different portfolios.




Portfolio 1: 50% Stocks / 50% Bonds
Portfolio 2: 60% Stocks / 40% Bonds
Portfolio 3: 70% Stocks / 30% Bonds

Assuming an initial balance of $10,000, the final balance for the 3 portfolios are shown above. By investing 70% in stocks and 30% in bonds, final balance is $25,000 higher than Portfolio 1. Does that make it the better choice? Not necessarily. This is readily available data, but you can't predict the future.

The purpose of having proper bond allocation is to have a safe portfolio. If one always thinks that "I won't be that unlucky" and heavily invests in stocks for an extended period, it may turn out badly.

By looking at the worst year performance, Portfolio 1, the safest allocation of 50% each, was down by 15.99% while Portfolio 3 was down by 24.41%. Worse still, if you invested 100% into stocks, you can see that the worst year for Vanguard 500 Index Fund was down by 37.02%. If you needed cash at the point where it has reached one of the bad years, you're probably going to lose your capital or returns if you only had stocks to liquidate. However if you had bonds allocated, in an emergency you could withdraw the bonds while waiting for stocks to have a few positive upturns in the next few years.

I always remind myself that greed is the cause of the downfalls. I would not look back ten years later and say "I should have went 100% into index funds for 5 years to have more returns". Instead, I will gladly tell myself, "I'm glad I've got a less risk adverse portfolio and I can afford to wait for the market to get back on it's feet if I need to sell my shares". 

Investments are always about calculated risks. If you decide to go all in and you are cool when the market is down, great for you. But if that year is the unlucky year, you only have yourself to blame for your greed.

From the performance of the portfolios, you can tell that bonds cushion your fall during an economic downturn and it is a must have asset in your portfolio.

Conclusion

Sometimes it's great to be a couch potato. But if you're going to be greedy, it's a risk that you are willing to take on. If you're a responsible person and have fully calculated your risks if you wish to go for a bigger portion of shares, always have something to fall back on during a downturn. For me, I'm a huge advocate of safe, quality returns.

I'll share more about a foreign ETF index fund that I'm interested to invest in my next post, and if I were to add that to my portfolio, I would go 40% STI ETF, 40% foreign ETF and 20% local bonds. However the principle is the same as it is always the allocation of stocks to bonds, so no worries if you only wish to have local stocks and bonds!

Questions or opinions? Comment below!

-WC