Active versus passive investment styles
A friend of mine says she invests in a “couch potato portfolio,” and her returns are higher than my portfolio of mutual funds, which the company says is actively managed! I’m not sure I understand what a “couch potato” portfolio is, or whether it’s something I should be using. Can you help?
Asked by C.S., Toronto, Ontario
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, so yes it is very possible your friend’s portfolio outperformed yours.
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.
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.
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.
If you’d like to discuss your situation further, feel free to connect with me.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.