Your Complete Guide to Index Investing with Dan Bortolotti

Scott Burns Interview: Part 2

2012-02-23T07:20:21+00:00February 23rd, 2012|Categories: Indexing Basics|19 Comments

Here is part two of my interview with Scott Burns, the newspaper columnist and Chief Investment Strategist at AssetBuilder who created the original Couch Potato portfolio more than 20 years ago. You can read part one here.

You’ve said that anyone who can fog a mirror can be an index investor, but as I’m sure you have found, even people who accept the academic arguments often cannot bring themselves to trust the markets.

SB: Absolutely. There are basically two issues here. First, there are the people who say, “I like the Couch Potato approach, but can’t I tweak it a little bit?” The moment they start doing that they are saying that they can forecast the market. They think it’s just tweaking, but they are starting down a road that ends in trying to foretell the future. I think there can be enormous flexibility in an index approach, don’t get me wrong. But when people come with the mindset of liking the Couch Potato but wanting to tweak it, the tweaks get larger and larger and ultimately they become fortune tellers.

The other issue is trust. More people today are wondering about the end of the world, and more people today are frozen at the switch, not knowing where to invest at all. I have never seen a more paralyzed market for the average investor. They just want to go somewhere and hide. I don’t know what we can do to restore things. We had this collapse [in 2008], and nothing has happened to the industry that brought it on. The reforms that were made were not very powerful, and there are efforts every day to lift those restrictions and allow people to go on gambling in the financial sector with public money.

Given all of these problems and the lack of any obvious solution in the short run, how do you make the argument that index investing is still relevant? How do you answer the critics who say that “blind faith” in the market doesn’t work anymore?

SB: There are multiple answers to that. Let’s start with the people at the extreme who are predicting utter disaster: that the dollar will disappear in a puff of smoke, or that we will be carrying dollars around in wheelbarrows. That event has been predicted since the 1940s, and it has been wrong for all of that time. It may come to pass, but you can’t run a portfolio or a financial plan based on black swan events, which by definition are unpredictable. As appealing as the whole black swan idea is, it is fundamentally not workable, because the other 99% of the time you’re going to be earning at least a reasonable return in conventional investments.

The other side of it is that we live in a world of unintended consequences. We never know exactly what the consequences of an action will be, but it is usually a surprise. Inventions come from out of the blue. We still can’t predict. So what is the only thing we can do? We can be as diversified as possible. And in that respect, the financial services industry has actually helped us, because since the start of the Couch Potato, when you could basically only invest in two asset classes, you can now get very broad diversification. The best we can do is diversify and hope that some asset classes will compensate for losses in the others.

One of my favourite model portfolios is called Six Ways from Sunday. It captures all of the basic asset classes without taking slices of value and growth: it’s two-thirds equities, and one-third fixed income. It’s simple, it uses the lowest cost instruments available, and you have complete representation of the major asset classes in the world. It’s not perfect, but if you’re after perfect you’re going to fail. The Couch Potato is about being good enough.

Index investors have far more opportunities today than they did five or six years ago, let alone 20 years ago. But I wonder if you agree that the huge number of choices that investors have today can overwhelm them and cause them to make poor decisions.

SB: You’ve put your finger right on it: Wall Street is creating yet another smokescreen that is highly profitable for them. There is a proliferation of funds that are entirely speculative vehicles. If you are buying an ETF that is premised on tripling the gain of the S&P 500, then you’re a speculator. If you are trying to make money with an ETF that rises in value when the world ends, you’re also a speculator. You’re not an investor. It’s hard for many people to get to the basic idea of simple.

The biggest problem isn’t necessarily product proliferation: I think the biggest issue we are facing now is the lack of income. It doesn’t matter where you go, in what asset class, there is essentially no income. But this is probably a great time to be an accumulator, even if it doesn’t feel that way. You know, 20 years from now people who are putting money in retirement plans today are going to feel just as good as the people who kept doing so throughout the 1970s. They will have accumulated assets that eventually take off, and they will do well.


  1. Chris February 23, 2012 at 12:34 pm

    It’s a little bit odd that he criticizes (i) trying to predict which asset classes will outperform, and (ii) the proliferation of ETF products, but simultaneously recommends as one of his “favorite” model portfolios a portfolio that includes a 17% allocation to the Vanguard Energy fund/ETF.

  2. Canadian Couch Potato February 23, 2012 at 12:41 pm

    @Chris: That surprised me a bit, too, but I think the reasoning is that he’s using the energy fund as proxy for commodities: most broad-based commodity funds are heavily weighted to energy anyway, and they are very expensive. This can be a good diversifier for a US-based portfolio— albeit it’s a terrible one for Canadians. He’s not making any kind of short-term call on energy: this is permanent position in the portfolio.

  3. John February 23, 2012 at 2:20 pm

    Thanks for the Part 2. Interesting reading as always.

    I see that his company is using DFA funds. Other than using the Powershares RAFI series as in the Uber Tuber, is there any way to get at products with this kind of indexing without sacrificing the 1% per year to an advisor?

  4. Dan Hallett February 23, 2012 at 4:37 pm

    DanB – Great couple of interivews. Well done.

    The first point in part 2 really resonates with me because I can’t tell you how many times somebody would boast of ETFs’ very real cost advantages but then turn around and put huge tilts on their portfolio or attempt to make tactical shifts. These investors scoff at active management in one breath but then embrace it in the next – probably without fully realizing the paradox.

    I was also a bit surprised by the energy tilt. There must be broader commodity based funds in the U.S. that include not just oil and gas but basic/precious metals, agricultural commodities and maybe even other hard assets like timber. In any event, at least there is an element of consistency and a rationale behind the positioning and that’s the big issue. And it is a good diversifier for U.S. and international stocks (ex Canada).

  5. Canadian Couch Potato February 23, 2012 at 5:01 pm

    @John: Unfortunately, DFA funds are only available through “approved” advisers. My understanding is this limits the cash flow in and out of the funds, which allows the managers to execute the strategies more efficiently.

    @Dan H: Interesting to hear that you’ve observed this, too. There does seem to be a subset of investors who think that passive products = passive strategy. Someone who hand-picks 30 stocks and builds a ladder of individual bonds (or who uses low-cost, low turnover active funds) has more in common with a passive investor than someone who makes tactical plays with ETFs.

  6. The Dividend Ninja » The Weekly Lineup: From Potatoes to Dividends February 25, 2012 at 1:22 am

    […] Bortolotti at The Canadian Couch Potato continued his interview with Scott Burns. Burns is the newspaper columnist and Chief Investment Strategist at AssetBuilder, who created the […]

  7. The Dividend Ninja February 25, 2012 at 2:17 am

    Stellar interviews Dan and Scott! :)

    The Dividend Ninja

  8. Andrew February 27, 2012 at 10:29 am

    I wonder if anyone could comment on the following:
    What about the idea of introducing an aspect of risk management toward a couch potato portfolio through the simple rule of selling to cash when the 10 month simple moving average of the asset is broken to the downside and only owning the asset class when it is above its 10 month SMA. Mebane Faber has a portfolio that has 5 asset classes, equally weighted (commodity, bond universe, equity domestic, equity international EAFE and REITs) that goes to cash below the 10 month SMA and rebalances annually.
    His tests indicate that this reduces risk adjusted volatility considerably. He concludes:
    “Utilizing a monthly system since 1973, an investor would have been able to increase riskadjusted returns by diversifying portfolio assets and employing a market-timing solution.
    In addition, the investor would have also been able to sidestep many of the protracted
    bear markets in various asset classes. Avoiding these massive losses would have resulted in equity-like returns with bond-like volatility and drawdown.”

  9. My Own Advisor February 29, 2012 at 1:02 pm

    Great stuff Dan and Scott.

    I really enjoyed reading what Scott said here: “We had this collapse [in 2008], and nothing has happened to the industry that brought it on. The reforms that were made were not very powerful…”

    I think many investors no longer trust the market, and you can’t blame them given the industry as a whole has done little to restore their confidence – at least that’s my opinion. As a consequence, probably lots of money “sitting on the sidelines”.

    Is there any data available to loosely validate this theory? Or not? More money in cash or bonds with investors now, than equities, pre- and post-The Great Recession?

    I hope Scott is right….
    “You know, 20 years from now people who are putting money in retirement plans today are going to feel just as good as the people who kept doing so throughout the 1970s.” I’m definitely in my accumulation phase with ETFs and dividend-paying stocks.

  10. Canadian Couch Potato February 29, 2012 at 3:44 pm

    @MOA: Glad you liked the interview. I don’t have the data handy, but I do know that there have been huge inflows into fixed income ETFs over the last three or four years, and there is still billions of dollars in money market funds earning 0%.

    I am pretty confident that investors who hang in there for 20+ years will do quite well. We have had many rough patches in the past, and they have almost always been followed by strong recoveries. The fact is, the last 36 months have been extremely good for both stocks and bonds, with returns way above average. But it doesn’t feel like that, does it? The shadow of 2008-09 is a long one.

  11. Len March 5, 2012 at 3:03 pm


    I too had read Faber’s website a while ago site and it speaks to the existential problem of couch potato investing (which I have been doing for about 6 years). I weathered the last down turn reasonably well with my CP portfolio because I had 50 % in bonds (I am +50 yrs), but it occurred to me as the rest of the portfolio declined that there must be a better and simple way to PROTECT my assets. It seemed so stupid to sit there (passively) and watch things drop, and rebalancing quarterly or once a year, knowing full well there was a crisis (so called black swan) happening, unless I truly believed things would get better eventually. Herein lies the crucial problem with CP investing – it fundamentally presumes that the market is cyclical but on the whole, and through rebalancing annually, it will move up in overall value given time, which has largely been the case for many decades. Personally, given the historically unprecendented massive bubbles in Canadian housing, massive US debt and deficit, personal debt levels in Canada and USA, and the US still printing money like no tomorrow, there is a good likelihood that ALL CP asset classes (stocks, bonds, REITS) stand to head seriously south and for quite some time in the near future as the US has only one direction to go. Passive rebalancing in this scenario will largely be futile, since the whole package is losing its value, just like rearranging deck chairs on the Titanic. This time it is indeed a different future for investing, we have never seen these economic conditions EVER in history, and its not looking very encouraging to me.

    For this reason, I really think that CP needs to develop some practical approaches ansd strategies to PROTECTING the CP portfolio, based on very rational criteria-based strategies as advocated on Fabers website – its a pretty compelling approach. And possibly starting to include a gold ETF as a hedge against inflation.

    Dan, so far CP investing has served me well, and I largely agreed with the philosophy, but I think the time has come to start the discussion about CP portfolio protection strategies. Unfortunately, I think that CP investing may have to be less passive with investors taking a more active role and more frequently than getting off the couch once a year.

    I’d like to hear your and others thoughts on this.

  12. Len March 5, 2012 at 3:10 pm

    I forgot to mention that Andrews link above is to a subscription website. Faber’s research on passive portfolio protection strategies by actively managing risk can be freely downloaded here:

  13. Canadian Couch Potato March 5, 2012 at 3:35 pm

    @Len: I’ll look further into Faber’s work and consider doing a whole post on it. But in general, I’m deeply skeptical of all of these techniques. I sympathize with the frustration, and I know that sometimes sticking to a strategic asset allocation makes you feel like a naive fool. But there are just so many problems with tactical and market timing strategies. The backtesting always assumes that the system was executed flawlessly and without costs. But even a few slip ups and any advantage can easily disappear. You are already second guessing the indexing approach despite a century of data, so what makes you think you you would religiously adhere to Faber’s strategy?

    One of your comments was very telling. You said that we “knew full well there was a crisis (so called black swan) happening.” But a black swan, by definition, is an unpredictable event. It is so easy in hindsight to say that “we knew it was coming”: indeed that is another characteristic of Taleb’s black swan idea. But we didn’t know it was coming. Any more than we “knew” that interest rates would rise over the last three years, or the euro would collapse. These fears have utterly failed to materialize despite three years of dire warnings that they were “certain.” They may eventually come to pass, of course, and when they do people will be quick to say they “knew it was coming.”

    We can’t predict the future, and there is no magic formula to protect you from market downturns. The best (albeit imperfect) solution is to spread out your risk across many asset classes, as you seem to have done. I would encourage you to look back over the last five years of asset class returns and you will see that there has been huge value in diversification.

  14. Len March 5, 2012 at 4:07 pm

    A detailed post on Faber’s approach in the context of CP investing would be fantastic (since I feel I am an amateur and increasingly cautious investor with >age). I totally agree we cannot predict market with much certainty, like the exact moment when it will rain, but we can see when storm clouds (e.g. macro-economic conditions) are gathering where its very probable it “might” rain sooon (and hence we choose to seek appropriate cover). No, I am not looking for magic formulae – that is what attracted me to CP investing in the first place – to keep the temptation for testosterone driven tinkering out of the resource pot for the sake of my family!

    Great website, by the way, I have benefited tremendously from the financial wisdom imparted here. Keep up the good work!

  15. Andrew March 6, 2012 at 3:52 pm

    Thanks for reposting Faber link.
    I feel the same way as you in some respects. I can explain how I use this type of method if you want: Its a variation on CP investing that has a tactical asset allocation based on value and momentum.

  16. Len March 7, 2012 at 12:55 am

    Andrew, Sure, a desription of your Faber implementation and track record on your CP would be nice. I am very reluctant to tinker with my CP portfolio for all of the sound reasons given on this site, so far i have only been checking end of each month to compare 200-day running average for each CP class with current value (couple of clicks in yahoo finance). Of course, over the past months since i started tracking its all been green lights, so its been passive CP as usual.

  17. Andrew March 9, 2012 at 10:31 am

    When I have more time I will do a detailed post of what I have done in the past and how I am changing things up a bit in future.
    The Faber paper was compelling and I know he is working with asset managers on Wall Street on quantitative tactical asset allocation and a refinement of what he is talking about in the paper.

    My take home message is that if you back test, using moving average crossovers and long term moving averages as indicators to add or subtract to more volatile assets such as stocks and REITs and commodities this does (or did) add value. So what I have done in the past is to use such rules to vary asset allocation incrementally.

    This compels me to work on a variation of this that is simple: rebalancing inherently puts more to assets that have declined in relative value and less to those that have increased. The problem is what happens if several asset classes decline simultaneously? For example it is possible that interest rates will rise causing longer duration bond ETFs to decline in value. But, and this is from research with CIBC (I had a dialogue with an economist there about it), when rates rise it usually has negative effects on equities (and especially REITs), the degree to which depends on the sector. So you could be faced with a situation where the entire portfolio has declined in value at the time of rebalancing. You would be rebalancing still but you would be doing it with less capital. The traditional rebalancing structure assumes that asset classes are uncorrelated and that rebalancing therefore adds value but not always.

    I want to rebalance with an absolute return as a whole which implies that capital is preserved whatever the conditions; in other words I want to have a return that beats the risk free return on a short (cash) or long term basis (real return bonds) so I have to have a rule that preserves capital as a primary consideration. Only then can we use another rule that adds relatively more to an asset class when it has declined in value relative to other classes and less, or subtracts from, an asset class that has increased. This can be accomplished through equal weighting rebalancing or some variation of it subject to certain personal tolerances for risk and time horizon. I know this sounds a bit muddled but the central message is that if a asset is declining in value, steadily over a long period of time ,it is not the time to own it or its better to own less of it.

    I also use an analysis of credit markets because they fundamentally drive economic and financial activity. So in a way my asset allocation at any time is tactically informed by technical analysis trend indicators and also fundamental credit conditions.

  18. Adam March 11, 2012 at 12:17 pm


    I have been reading your website now for about a year. I am early in my career as an investor, as I am still in my 20’s. I began investing in 2009, so I have not been able to test my nerve using your strategy in a large crash, although I kept my head during 2011. I personally believe this is a fantastic strategy versus my old strategy of attempting to pick value stocks (a few big payoffs, a few big value traps) and dividend stocks. One complaint I have with your website is how little on commodities discussion there is, and overall lack of direct exposure to commodity prices in your model portfolios. Is this because you believe that commodities are largely a game left to professionals? I have read up on a number of products that use futures trading and other strategies that are not for me. Are there any that you would recommend? In particular MNT seemed attractive. Thanks for your time and keep up the great work!

  19. Canadian Couch Potato March 11, 2012 at 2:58 pm

    @Adam: Thanks for the comment. You raise a big topic, but the short answer is that most Canadians have plenty of commodity exposure already if they hold a significant part of their portfolio in Canadian equities. All of the research I have read about the benefits of adding commosdities to a portfolio (notably Larry Swedroe’s work) uses data comparing their performance to the S&P 500, which has very little exposure to natural resources. By contrast, energy and mining make up almost half of the Canadian stock market.

    There are also some practical problems with commodity ETFs that get their exposure through futures contracts: they can be very expensive and tax-inefficient. That said, If an investor wanted to keep, say, 10% of a portfolio in a low-cost, physically backed gold ETF, I wouldn’t argue strongly against it. Gold does have a low correlation with stocks and bonds and can be a useful diversifier. However, I think iShares IGT is probably the best product to accomplish this.

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