Canadian Couch Potato

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Couch Potato FAQ

What is the Couch Potato strategy?

Tw eet

The Couch Potato strategy is a technique for building a diversified, low-maintenance portfolio designed to deliver
the returns of the overall stock and bond markets with minimal cost. The strategy can reduce a typical investors
costs by as much as 90%, while at the same time beating the majority of mutual funds and professionally
managed accounts.
The strategyalso called index investing, or passive investinghas been around for decades, though it has
become far more popular in recent years, as new products and online discount brokerages have made it easier to
implement. Anyone can now build and maintain their own portfolio using index mutual funds and exchangetraded funds (ETFs).

Whats an index mutual fund?

First its important to understand what an index is: its a group of stocks or bonds used to measure the
performance of a particular market. For instance, the S&P/TSX Composite includes about 250 companies
traded on the Toronto Stock Exchange, and its considered a barometer of the entire Canadian stock market.
Similarly, the Dow Jones Industrial Average, the S&P 500 and the Russell 3000 are indexes that measure the
US stock market. The MSCI EAFE is a popular index of international stocks. Other indexes measure the fixedincome market, such as the widely used DEX Universe Bond Index, which covers both government and
corporate bonds in Canada.
An index mutual fund holds all (or almost all) of the stocks or bonds in a particular index. The idea is to produce
a return equal to that of the overall market. Thats different from the goal of actively managed mutual funds,
which try (usually unsuccessfully) to choose individual securities that will outperform the market. To use a
favourite phrase of John Bogle, the father of index investing, instead of looking for the needle in the haystack,
index funds just buy the haystack.

What are exchange-traded funds (ETFs)?

Exchange-traded funds, or ETFs, are similar to index mutual funds in that they hold a basket of stocks or bonds
and track a specific index. However, unlike mutual funds, ETFs are bought and sold on an exchange, like stocks.
While investors typically pay a commission to buy and sell them (just as they would when trading stocks), ETFs
typically have lower annual fees than index mutual funds. There is also a much wider selection, offering investors
access to almost every kind of asset: stocks, bonds, real estate, commodities, precious metals, currencies and
more.

Where does the Couch Potato name come from?

In a 1991 article, Scott Burns, then a financial writer for the Dallas Morning News, suggested investors simply
put half their money in an index fund that tracked the S&P 500, and the other half in a fund that tracked the US
bond market. Every year, he said, rebalance the portfolio so its once again 50% stocks and 50% bonds. You
need to pay attention to your investments only once a year, he wrote. Any time its convenient. Any time you
can muster the capacity to divide by the number 2. He called his ultra-simple investment idea the Couch Potato
portfolio.
When MoneySense magazine was launched in 1999, founding editor Ian McGugan brought the Couch Potato to
Canada. Since then, MoneySense has remained a leading source of information about index investing, especially
through the features and columns of Dan Bortolotti.

How can such a simple strategy beat the pros?

To many investors, the idea that the Couch Potato strategy can beat most professional money managers seems
ridiculousas though someone were selling a golf strategy that could beat most players on the PGA Tour. The
difference, however, is that pro golfers routinely shoot under par, while most mutual fund managers underperform
the overall market. Standard & Poors reports that over the five years ending in 2011, 97.3% of actively
managed Canadian mutual funds failed to deliver better returns than their benchmark index.
Rather than paying money managers high fees to try in vain to beat the market, Couch Potato investors simply
aim for market returns at the lowest possible cost. After all, no one needs to beat the market to be a successful
investor. Investors who save diligently and simply earn market returns should have no trouble reaching their
financial goals.

Why is my advisor trying to talk me out of it?

Indexing strategies are used by the most sophisticated pension and endowment fund managers in the world, and
many of its proponents are Nobel laureates. Yet many financial advisors are contemptuous of the idea. The
reason is simple: advisors often make their money from commissions and fees on the investment products they
sell. As Upton Sinclair wrote, It is difficult to get a man to understand something when his salary depends upon
his not understanding it.
Many investment firms dont even offer index funds (theyre not profitable enough), and many mutual fund
salespeople are not licensed to sell ETFs. If you want to adopt a Couch Potato strategy, youll need to build

your own portfolio with an online discount brokerage account, or find an advisor who advocates indexing.

How do I become a Couch Potato?

If youll be managing your portfolio yourself, start by opening an account with a discount brokerage, which will
allow you to buy investments online. To learn about the major brokerages in Canada, see The Globe and Mails
annual online broker survey and read this review on the MoneySmarts blog.
Another option (especially for smaller portfolios) is to open an online investment account with TD Mutual Funds,
which offers a family of low-fee index funds that are only available to its online customers.
If youll be parting ways with your advisor, tell him or her to sell all your current holdingsstocks, bonds, mutual
fundsand transfer the cash to your new brokerage account. This will involve some paperwork and fees, and it
may take a week or two. Your discount brokerage can help, and will often pay the transfer fee if youre moving
a large sum.
Once all the cash is in your new account, you can build your new Couch Potato portfolio with index funds or
ETFs.

Should I use index mutual funds or ETFs?

The decision between index mutual funds and ETFs depends on several factors. Here are some rules of thumb.
Choose index mutual funds if:
youre investing less than $50,000
you plan to make small, regular contributions
you want to keep your portfolio simple, with just the basic asset classes
youre not comfortable buying and selling ETFs in a discount brokerage account
Choose ETFs if:
youre investing at least $50,000
you plan to make infrequent, lump-sum contributions
you want to include asset classes that are not available through index mutual funds (such as real estate,
emerging markets, and real-return bonds)
youre comfortable using a discount brokerage to place trades
youre able to open a discount brokerage account with no annual fee, and that charges no more than $10
per trade
For more, see Comparing the Costs of Index Funds and ETFs.

Which funds or ETFs should I use in my portfolio?

See the Model Portfolios page for suggestions.

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