Active versus passive investment styles
The “couch potato” portfolio is so named because it takes a “passive” approach to investing. It is predicated on the theory that markets are efficient, or smarter, than any single person. Studies have shown that the passive, or couch potato, investment strategy on average beats about 80% of professional money managers over time. For time-squeezed Millennials who would rather do almost anything else than manage money, this strategy can make a lot of sense.
What’s the difference between “active” and “passive” investing?
When it comes to investment strategy, investors are generally in one of two camps, active or passive. Active managers try to beat the market by buying and selling securities in hopes of making a profit. Passive investors simply buy the market. In a passive, or couch potato, portfolio, you buy a piece of the entire market instead of trying to make a call on which company or asset class will do better than another.
To accomplish this, an investor would buy a series of both equity and fixed-income index mutual funds or exchange-traded funds (ETFs) and simply hold them. Exchange-traded funds are cheaper than mutual funds, with an average MER of 0.5% compared with 2.5% for actively managed mutual funds. Straight off the hop, you put 2% more in your pocket and you have achieved diversification, because you have bought the entire market.
What are the risks?
There are investment risks associated with the couch potato portfolio, as there are with any investment strategy. If the market drops steeply, as it did in 2008, your portfolio will drop right along with it. But the opposite is also true. If the market rallies, your portfolio will rise in value.
Because your various holdings are likely to change in value over time, once a year, you should “rebalance” your couch potato portfolio back to its original asset weightings.
What are the costs?
The question is whether you believe that active managers can provide return over and above the market after fees, or whether markets are in fact “efficient” and will outperform an active-management style over the long term. If you select the passive, couch potato portfolio, be prepared to stomach the ups and downs of the market solo. If you select actively managed mutual funds, be prepared to pay a higher fee and have the support of a professional money manager or advisor during market turmoil.
Personally, I believe in using both strategies. I deploy what’s called a passive strategy with an active overlay, buying the market and making only small calls in an attempt to outperform.
How to get started
Create an investment plan that matches your risk-tolerance level. For example, it makes absolutely no sense to say you’re a conservative investor and then jump into trading penny mines on the TSX Venture Exchange. Once you’ve set your investment plan in motion, track it weekly or monthly.
If you select the passive, couch potato portfolio, be prepared to stomach the ups and downs of the market solo. If you select actively managed mutual funds, be prepared to pay a higher fee and have the support of a professional money manager or advisor during market turmoil. Personally, I believe in using both strategies. I deploy what’s called a passive strategy with an active overlay, buying the market and making only small calls in an attempt to outperform.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.
