Your Complete Guide to Index Investing with Dan Bortolotti

An Interview with the Original Couch Potato

2012-02-20T16:09:56+00:00February 20th, 2012|Categories: Index funds, Indexing Basics|10 Comments

“Allow me to introduce the Couch Potato Portfolio, a surefire formula to invest your money, enjoy a return that will put you in the top half of all professional investors, but expend virtually no effort or thought.”

That’s how Scott Burns began his column in the Dallas Morning News on September 29, 1991, and the Couch Potato strategy was born. Index funds, of course, had existed for some 15 years by that time, but it was Burns who helped popularize them with Joe and Jane Investor in countless articles that followed. In 2006, Burns left the newspaper to found AssetBuilder,  a firm that helps investors build low-cost, passively managed portfolios inspired by the original Couch Potato.

I recently had the opportunity to chat with Scott Burns about the early days of index investing. Here’s an excerpt from our interview.

During the 20 years since you created the Couch Potato portfolio, we’ve seen an enormous evolution in index investing. Can you take us back to 1991 and describe the investing climate back then?

SB: Let’s go back a little further. I have been writing about personal finance since the late 1960s. I became a newspaper columnist in 1977 in Boston, which was the heart of the mutual fund industry. I would get to interview these portfolio managers who had terrific records one year, and then the next year the fund would basically blow up—sometimes not that dramatically, but over time I realized that the odds were against actively managed funds.

The best exercise that I ever saw was done by a newspaper company called Media General. Its chairman in the early 1970s computerized the idea of the “monkeys throwing darts” portfolio. He used a mainframe to generate randomly selected portfolios, and then the computer would rank their performance, and this was published as a full page in The Wall Street Journal. I would check individual funds against these listings, and the majority were always below the 50th percentile of the randomly selected portfolios.

A whole body of research was soon being compiled around this idea: Charles Ellis had pointed out [in a 1975 paper] that active management was a loser’s game. And then John Bogle dared to start an index fund in 1975, and everybody thought he was going to just disappear. Well, he didn’t.

When Vanguard started its S&P 500 index fund they charged something like 45 basis points, which is very expensive compared with today, but it was way cheap compared to the average fund back then. It was about a third the cost. So for the fund companies, this was a nonstarter. As Bogle has pointed out many times, they wondered why they would want to start a fund that would earn only a third as much money. Somebody had to dare to build a model that would attract money in sufficient volume that would sustain a business with those low fees. Bogle took a gigantic gamble, and it was absolutely not an overnight success.

By the late 1980s and early 1990s, were people finally warming to the idea of index investing?

SB: Lots of people began to notice that they were paying a lot of money to have their investments managed, and their funds were not doing very well compared to index funds. But the issue is, how do you get people to actually do it? It’s one thing to ask questions; it is another thing to take action. Most people are simply too intimidated. All they need is a salesman talking to them and showing them a bunch of numbers, and most people want to leave the room.

So the idea for the Couch Potato was to simply put half the money in fixed income and half the money in equities. That was the simplest way—I mean, if you could fog a mirror, you could be a Couch Potato investor.

The early numbers showed that if you did it in a bear market, you would obviously beat the S&P 500, because you had half in fixed income. And if you did it in a bull market, you lost very little relative to an all-stock portfolio, and you got to sleep for the whole period. That first column in 1991 shows two major periods: a bull market and a bear market. The whole period of the 1970s was a bear market, and the 80s was a bull market, so it was pretty definitive.

I’m not surprised that the Couch Potato fell on deaf ears within the industry. But I’m interested in how individual investors reacted to it. Did people think you were nuts for recommending such a simple portfolio?

SB: The first reactions came about as a result of lies told by people who sell funds. Brokers lie. That’s one of the things we just have to deal with: the sell side lies. Their education, by and large, is a marketing education. They get trained in arguments that are totally untrue.

The other thing is that people want to believe that there is someone out there who knows the future. Because they want to offload the possible embarrassment that would come with making bad decisions.

There is a leap of faith that has to be made to become an index investor, and it’s fundamental. You have to accept the idea that although we’re miserable, grubby, money-seeking wretches, somehow on balance human beings are creating more value than they are destroying. You have to believe that even though there will be Enrons and WorldComs, companies like Apple and IBM and Johnson & Johnson will create more value than the failures destroy.

Once you get to that belief, you can have some peace with the idea of being an index investor. But that’s very difficult to do in the current environment: we would all really like to believe that there is some path to safety.