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Vincent wrote to tell me about “lazy portfolios”:
Paul Farrell of MarketWatch tracks a group of portfolios composed of index funds, and watches how they are performing vs. the S&P 500. He writes an update a couple of times a year, with both a long-term and short-term perspective. The portfolios consist of as many as eleven funds and as few as three funds. I like reading the series because year-after-year, without exception, these lazy portfolios beat the S&P 500 over the long term.
Farrell’s most recent analysis of these portfolios was in January. He wrote:
Unless you’re working full-time in the financial world, you don’t have the skills, tools, information, time or interest in playing the market, especially the bond market. And even if you do play the market, the odds are you’ll lose because the more you trade the less you earn; transaction costs and taxes kill returns. So for 94 million out of America’s 95 million investors, being a lazy investor is the best defensive strategy.
In fact, even the hotshots working full-time in the financial world follow the same strategy with the bulk of their assets. It’s their biggest secret. Mutual fund managers making an average $400,000-plus playing the market with your money, often lock away the bulk of their retirement assets in safe, untouchable portfolios using a variation of a lazy portfolio strategy. Why not, they’re no dummies, they’ve got families to protect too.
In his analysis, Farrell provides portfolios from five money experts. These are portfolios that you can emulate. Which one is best? Farrell says: “Any one is better than wasting your time chasing hot stocks and the other 8,000-plus actively managed funds, 80-85% of which underperform the market every year.”
When I finally pay off my debt (less than a year to go!), I plan to put the bulk of my money into index funds. (I’ll set some money aside to explore two other options: stocks that pay dividends and “value” investing.) I used to think it would be fun to get rich day trading — a story for another day — but in the last few years I’ve learned I’d rather spend my time writing. I’m happy to stick my money into an index fund and let the market take care of the growth. Lazy portfolios are perfect for me.
[MarketWatch: 'Lazy' portfolios beat benchmarks again; here are top performers]
This article is about Investing Friday, 30th March 2007 (by J.D. Roth)
March 30th, 2007 at 5:49 am
I take a similar approach to the lazy portfolio, but not exactly. I still enjoy picking my own stocks, but I’m basically assembling my own “mutual fund”. The difference is that it’s made up of only my money. I deposit money into my scottrade account, and when I find a stock that I like, I buy it. I don’t actively buy and sell, but i try to buy good companies, hold on, and check on the periodically as their reports come out.
It’s not the most lazy thing, but I find that I’m able to learn more than if I just parked my money in a fund. It’s whatever works for you though. Happy investing
-limeade
http://fiscalmusings.blogspot.com
March 30th, 2007 at 5:56 am
I agree that “lazy investing” does offer the best returns over the long run, but I personally prefer to allocate a portion of my portfolio to individual stocks as well. Higher risks, higher returns.
March 30th, 2007 at 6:20 am
I read a similar report on CNN Money about an 8 year old that had crafted a portfolio that would be most managed portfolios by a long shot. They were all Vanguard Index Mutual Funds.
March 30th, 2007 at 6:48 am
I think there are two things that motivate many people to ignore the overwhelming evidence that index funds are the best choice for most people: 1) they want to feel like they’re in control of their investments, and therefore want to actively manage them, 2) the fact that many smart (and lucky) investors have been able to beat the market fairly consistently in the past gives them the sense that it’s financially responsible to pick stocks and actively manage one’s investments rather than use index funds.
In fact it’s a gamble, and as with any game of chance some people will beat the market consistently with their own managed funds and individual stock picks. Most of them will do so through sheer luck disguised as wise investing.
March 30th, 2007 at 6:57 am
Great advice. People should stick to what they’re good at.
March 30th, 2007 at 7:22 am
I think the “lazy” approach is picking up steam and the market becomes more uncertain. On some level, even risky people with hedge their bets and make 8% instead of aiming for 18%.
The way to get around the “I need to be in control” feeling is to just allocate a small portion of your portfolio to yourself. Treat it like a game if you must, see if you can beat the rest of your portfolio that is hands off, whatever is necessary to make it interesting, but that part of my portfolio will always be significantly smaller than my “real” portfolio that is hands off.
March 30th, 2007 at 7:27 am
I’ve been a lurker at this wonderful site for quite some time, but I just had to jump in today because the S&P 500 is an INDEX FUND IN AND OF ITSELF!! And it’s a pretty darn good one to boot … the S&P 500 has averaged over 10% per year for the last 70 years or so! So this lazy guy is beating a great index w/ an index? It’s important to realize that many people’s 401ks, 403bs, or 457 plans only have ONE index fund for them to choose from, and very often that fund invests solely in the S&P 500. Point is, the S&P 500 is not necessarily something to “beat,” but rather a great index to invest in itself.
March 30th, 2007 at 7:44 am
In my retirement account, I am starting to construct one of the lazy portfolios using the Vanguard ETFS since my self-directed brokerage account option doesn’t allow me to but the Vanguard mutual funds without an exorbitant fee. There is a commision on the ETF trade so it’s smaller, so whenever I meet my threshold for a purchase I go ahead and make the next installment to my portfolio (it’s “dollar cost averaging” on a much longer time frame — like 1-2 trades in per year).
The ETFs have even lower fees than the index funds and are really the same thing, so if you wanted to build one of these portfolios on Sharebuilder or something comparable that’s entirely feasible there (though I’d still save up and make as large a purchase as possible to beat the small commission). Still, if you can meet Vanguard’s minimums you’d do just fine to stick to the mutual fund flavor.
The ETF equivalents that I’m utilizing are VTI for VFINX, and the new VEU for the Total International.
I got the idea from Farrell and his intrepid 8 year old.
For the remainder of my 401(k) I’m partly in a closed-end fund that pays a nice monthly (yes, monthly!) dividend, and I utilize CDs and my sweep account (which currently gets interest that beats my ING account) to hold cash in my 401(k). (NOTE: I’m not sure of the tax implications of holding my closed-end fund outside of a tax advantaged account.)
If you have a chance to snag a self-directed 401(k) grab it! My regular 401(k) choices are limited but ok, but I like the selection within my self-directed account better.
db
http://www.debtblitzkrieg.com
March 30th, 2007 at 7:46 am
Dave, my understanding is that the S&P isn’t actually a fund. It’s an index, yes, but only in a tracking sense. There are S&P index funds, but the S&P 500 itself isn’t a fund. (Please do correct me if I’m mistaken.)
And the way these people are beating an index with an index is by using a portfolio of indexes. That is, they create a group of funds that track multiple indexes. By diversifying, they’re able to do better than the S&P 500 over the long term.
March 30th, 2007 at 7:54 am
Note: as of right now I’m passing on the bond portion until Vanguard’s Total Bond ETF comes out. Though I hold comparable amounts in cash and right now get better interest on the cash than I would on the bond fund. As time goes on I may bypass the bond fund altogether and stick with buying straight bonds or Treasuries (which are available inside this account), but I need to learn more about those options first.
One final thought: I only started this self-directed account option early last year and transferred all of my existing 401(k) into it. At first I was controlled, but I noticed that when I got more comfortable with it and especially when I started researching ETFs (because frankly the available mutual funds weren’t impressing me and I was just as well off with my low cost options in my regular account), I started making a lot of ETF trades. So the second part of last year was a demonstration of how trading too often dings the bottom line! I was glad I finally let the concept of the lazy portfolio into my thick head; otherwise I was considering abandoning the self-directed 401(k) simply to control myself from overtrading.
P.S. Sorry for the dumb typos in the above posts from me.
db
March 30th, 2007 at 7:57 am
JD, your point on the S&P 500 is correct. To buy the S&P 500 you either have to buy a fund (or ETF) that models the S&P 500, or buy the stocks that comprise the S&P 500 (in which case you’d probably be limited to just modellng a portion of the S&P 500.
March 30th, 2007 at 8:59 am
Monetary transaction costs can be eliminated using a Zecco.com account, though from my experience heavy trading can have significant costs to sanity, time, and relationships.
March 30th, 2007 at 9:28 am
i need a “very very beginner’s guide to investing,” i have no idea where to start!
March 30th, 2007 at 9:53 am
You are correct, JD — the S&P 500 isn’t actually a fund … I only meant IN ESSENSE it is, as many index funds TRACK it. But my main point is only that maybe people shouldn’t be so concerned with “beating” the S&P … maybe the key is to get concerned with INVESTING in the S&P, esp. since it has averaged around 11 percent per year for the last 70 years, and it’s the most passive, lazy thing one could possibly do, along w/ just tracking one of the other broad generic indexes like The Wilshire 5000. I understand what you are saying about beating the S&P w/ multiple index funds, but I just wouldn’t want anyone to ever get “scared out of” the S&P itself … 11 percent or so is just fine for most people.
March 30th, 2007 at 10:12 am
JD,
Touching on a topic I’m very interested in. From personal experience, I find one of the biggest challenges in investing wisely is similar to the biggest challenge in budget management: tracking your performance. I find it very difficult to get a highly accurate figure on how I’m performing. And in this field, a single percentage point is a significant difference.
In budget management, one of the most difficult things is to establish the discipline to track your own expenses week in and week out for years on end. It took me about four years to get the hang of it. For the first two or three years, there would be periods of up to three months where I would slack off and not track my spending. This would throw my annual budget out of whack and I’d be back at square one.
Similarly, in investing, it is difficult to track all the accounts and have an accurate picture of how you’re actually performing. You have to track multiple accounts: brokerage accounts, RRSPs (401ks for you Yankies), cash accounts. Then, you need to track their performance: stocks purchased, bonds sold, interest earned, interest paid, dividends earned, capital gains or losses, taxes paid, and the list goes on. To add to the complexity, an investing strategy takes at least ten years to validate. Some might argue it takes about twenty years to validate. There are fluctuations in the market that can last for seven years and make you look like a hero when you’re actually just lucky, and vice versa.
Good data is very hard to come by. Many people quote the “80% of actively managed funds are outperformed by an S&P 500 index fund.” However, I challenge anyone to produce the data that actually shows this. I’m not disputing this fact, I’m just saying that most people guide their personal finances based on anecdotes, not on actual data.
squished
March 30th, 2007 at 10:43 am
@squished: if you look at some of the other recent posts in GRS that discuss index funds, you’ll find links to data and studies to support the conclusion that 80 percent of managed funds are outperformed by an S&P 500 index fund.
As for the statement that “in investing, it is difficult to track all the accounts and have an accurate picture of how you’re actually performing,” I’d argue that this is only an issue if your investments are for relatively near term use rather than retirement. Personally I have no idea how my retirement investments are doing, and I don’t care. They’re mostly in a range of index funds with a small percentage in growth funds and a much smaller percentage in bonds. I don’t track them because I’ve got them in there for the long haul so it doesn’t matter to me how they’re doing now. All I care about is how they’ll be doing in 20 years when I retire. Sure, I could move things around every year to give myself the illusion that I’ll be getting a better return, but in fact the odds are that I’d do just as well if not better in the end if I simply let everything sit where it is for the next 20 years. So that’s what I’m doing.
March 30th, 2007 at 10:59 am
For those Canadians among us, Moneysense magazine has presented over the last several years their “couch potato portfolio” which is somewhat similar - but geared more towards the Canadian Investor.
The Moneysense website is moneysense.ca but a quick googling of “Couch Potato Portfolio” will get you there just as quickly.
March 30th, 2007 at 11:04 am
The S&P 500 is not “The Market.” It is an index of one arbitrary segment of the market (500 really big companies selected by a small group of people at a publishing company behind closed doors). So beating it is not the same as beating the market. The S&P 500 is not the best performing index of all time either.
It is normal for portfolios of index funds that track other indices to beat the S&P 500 because U.S. large cap stocks are not always the best performing asset class. In fact, most of the time it is not the best. This is why we diversify. Value and small cap indices have trumped the S&P 500 for the better part of a decade.
I agree that lazy is the way to go, but not because it’s been topping the S&P 500 in recent years.
When you boil it all down, trading is a less-than-zero sum game because of expenses that must be paid to financial intermediaries. There has to be more losers than winners in any given year. So, as hard as it is to be a winner, it’s exponentially harder to do it for multiple years or decades.
@ Squished - For stats about active funds vs. index, check out http://www.indexfunds.com/, It has lots of data from Dalbar and Morningstar, among others. Pay particular attention to Step 5.
March 30th, 2007 at 11:37 am
I think lazy is the way to go because it reduces the tendency to greed and emotion that comes with following the latest trends. Trend following is fine for a small portion of your wealth, but the bulk of your wealth should be invested the long, lazy way! That will help keep it there over the long term so someday you can be lazy!
db
March 30th, 2007 at 12:29 pm
Heya,
Short-time reader, first time poster (hah)!
The portfolio’s you outline sound remarkably like another I had heard about a few years ago called the “Couch Potato” portfolio.
Do a Google on “Couch potato moneysense” and read up on them if you are interested. I have just this year finally started to buy my mutual funds based on the Classic Couch Potato using mutual funds. When I have enough in my RRSP (I’m in Canada by the way), I’ll switch to ETFs (I am guessing I will need at least $5k to make ETFs viable) and I only have about $2200 in my RRSPs at the moment.
In any case I enjoy your site.
Cheers,
Keith.
March 31st, 2007 at 11:16 pm
It’s difficult to pass on a forum of this caliber. Nice work on ironing out the S&P Index issue.
I don’t think anyone will argue that ‘lazy’ is a relative term. For more than a decade now, my position has been that valuations in the market require monitoring even if it’s only two or three times a year. This tactic works well for investors who can plug into to trustworthy services that offer simplistic guidelines on portfolio reviews.
Also, beating the S&P 500 is, indeed, not always the best standard, nor is it a panacea for meeting personal targets. For example, money market funds outperformed the industry’s favorite benchmark between January 2001 and March 2003.
In all due respect to “laziness” (and the great reference to greed containment), I suggest maintaining an Excel file with a simple quarterly total return report, to include sales and dividends, maintained in a spreadsheet format. This system works with liquid asset and comes highly recommended for people who want to be lazy ten years from today.
April 3rd, 2007 at 10:37 pm
[...] Beat the Market with Lazy Portfolios ? Get Rich Slowly (tags: finance money investing) [...]
April 4th, 2007 at 7:14 am
The article does not mention the fact that Vanguard Index Funds require a minimum of $10,000 per Index Fund, otherwise, you will be assessed a fee of $10 per fund, per year. In other words, you need to have about $100,000 to invest in Bogle’s lazy man portfolio if you want to avoid annual fees.
April 4th, 2007 at 11:39 am
Perfect timing! I am looking for funds for my roth IRA. Thanks for the article.
April 13th, 2007 at 2:19 am
To me, just tracking the S&P500 over the long term seems a great way to go. Average return of 11% over the last 70 years? Who can complain against that?
I’m from the UK and we have ISA (Individual Savings Accounts) over here that allow us to invest in (some) foreign indices. Maybe I’ll have a mix of the S&P500 and the FTSE100?
April 28th, 2009 at 10:06 pm
@Bill:
This is simply not true. The minimums range between $1-3k. And if you sign up for e-statements your $20 annual fee is waived. Viola1!