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Index Investing: The Couch Potato Strategy

Russet potato

To go travelling for a year, Ms DGI&R had to quit her job. I was fortunate enough to be able to take a year leave and come back to the same job. Since we’ve been back Ms. DGI&R has been working a temp job and looking for work. Some more concrete options have emerged recently, but one of the job offers doesn’t offer any type of pension plan. This got me thinking of different options for her. I decided that this can be made up for with a higher salary and diligent savings routine.

I’m a dividend growth investor (DGI), so you would think, we would just pocket the extra money and invest it in dividend growth stocks. My DGI strategy involves buying quality dividend growth stocks at cheap prices. My entry criteria for “cheap” is fairly strict, so I spend a considerable amount of time waiting for prices to drop. When you wait around for a long time you are losing potential higher returns because you are out of the market.  This is why I thought adding a couch potato element to our portfolio would be a good idea. The couch potato strategy involves investing in a few index ETFs based on your risk tolerance and then rebalancing at a set interval. It got its name because it doesn’t involve a lot of hands on effort. You can laze on the couch while making a decent return.

If Ms. DGI&R gets the job I will strongly consider setting up a personalized pension plan based on this strategy for a number of reasons:

  1. It’s easy.
  2. It doesn’t take a lot of time.
  3. It can have low fees. The plan I came up with would have a MER% around 0.25%.
  4. It will beat 80-90% of actively managed mutual fund returns over a 5 or 10 year period.
  5. It provides instant diversification.
  6. Rebalancing based on asset allocation will generally force you to buy low and sell high.

You may be thinking this sounds great, but if it’s so great why haven’t I always been doing this? I’m relying on an increasing stream of dividend to support my retirement expenses. I’m more focused on dividend income vs capital gains which is the main reason I use a dividend growth strategy. Don’t get me wrong capital gains are still important, but my main focus is on an increasing stream of dividend income. When you invest in dividend paying companies that regularly increase their dividend, capital gains will generally follow.

I think down the road my portfolio will be a mix of dividend growth stocks and low cost index ETFs as I like both strategies and I think the two strategies could work well together. While I don’t currently use the Couch Potato method I did set my sister up with this strategy a few years ago as she doesn’t have a lot of interest in stocks and wanted a hands off approach. The other reason is I’m a DG investor, is that I like dividend growth investing and have an interest in the topic.

If you want to learn more about the couch potato strategy check out the Canadian Couch Potato blog. It’s a great website. On the site they have a variety of different model portfolios. I used the complete couch potato as a starting template and made some adjustments to come up with the following:

Canadian Equity – 25%

VCN - Vanguard FTSE Canada All Cap Index ETF (Estimated MER%: 0.15%)

US Equity – 20%

VUN – Vangaurd US Total Market Index ETF (Estimated MER%: 0.18%)

International Equity – 20%

15% – VDU – Vanguard FTSE Developed ex North America Index ETF (Estimated MER%: 0.34%)

5 % – VEE – Vanguard FTSE Emerging Markets Index ETF (Estimated MER%: 0.40%)

Canadian Real Estate Investment Trusts (REITs) – 10%

VRE – Vanguard FTSE Canadian Capped REIT Index ETF (Estimated MER%: 0.40%)

Canadian Bonds – 25%

VAB – Vanguard Canadian Aggregate Bond Index ETF (Esimtated MER%: 0.26%)

This portfolio would have a MER% of 0.25% with a 65% allocation in equities, 10% in REITs, and 25% in bonds. Ms DGI&R and I are in our mid to late 20s, so we have higher allocation in equities. As we approach retirement, we’d consider lowering our equity exposure and increasing our fixed income and bond allocation.

You’ll notice that I’ve chosen all Vanguard ETFs. This isn’t a mistake. Vanguard generally has the lowest MER% which is why I like them. Also going forward I believe that if someone else drops their MER% Vanguard will decrease their fees to be competitive. Vanguard is the low cost leader, but some of the ETFs shown are quite new to Canada, so you may want to consider other more established options. Check out the Canadian Couch Potato for alternatives. You may also want to consider adding some real return bonds to the portfolio, but I chose just to stick with the Vanguard Canadian Aggregate Bond Index ETF.

If Ms DGI&R takes the job I think I’d have her contribute 10-20% of her gross pay into this type of portfolio. So what do you think of my private pension plan?

 

Photo Credit: Foter.com / CC BY-SA

8 comments to Index Investing: The Couch Potato Strategy

  • Bernie

    Why not just purchase one fund the “CI Signature High Income Fund” instead. It has an equal mix of equities & bonds with a 1.60% MER. The equity portion isn’t quite as diversified as the couch potato portfolio but the performance is far superior.

    • A few reasons. The first is the high MER%. The portfolio I came up with has a MER% of 0.25% vs 1.6%. Generally I try and keep my costs below 1%. Secondly, while the CI fund has performed well in the past, this does not mean that future performance will be good. I only had a quick look at the CI fund, but from what I could tell it is an actively managed fund. The odds of an actively managed fund beating the performance of it’s benchmark index get less and less as more time passes. I did some quick Googling and found a S&P report for the year end 2011. Here’s a quote:

      “In the past five years, only 2.7% of actively managed funds in the Canadian Equity Funds category outperformed the S&P/TSX Composite (see Report 1). There was a similar result for the past three years, with only 8.5% of active funds exceeding the index return.”

      Vanguard has some more recent analysis on the topic too: https://www.vanguardcanada.ca/individual/articles/education-commentary/indexing/indexing-cost-advantage.htm#appeal-of-active-approaches

      Their findings:

      “Canadian actively managed funds have fared poorly, on average, versus their benchmarks over the past decade.”

      It comes down to the odds for me. I’m investing for the long term, so I try and avoid actively managed mutual funds.

  • Doug

    The overall yield seems to be quite low. I made a quick spreadsheet for the portfolio, and (unless I messed up), the annual dividend yield is about 1.6%. I bet your personal portfolio has a much higher yield.

    PS Thanks for the blog – I follow it religiously, and have recommended it to others.

    • I hadn’t looked at the yield, but it might be because some of the indexes are new. I read an article from the Canadian Couch Potato that was talking about VRE and it explained how new ETFs that are growing rapidly can have a lower dividend yield initially. It’s kind of complicated to explain in a short comment, so I’d just read the article as it explains it quite well.

      The other issue comes from the way Vanguard typically pays out its dividend which the Canadian Couch Potato article also explains. ETFs “are required to distribute their income to unitholders in the year it is received, but not necessarily in the same month. Many funds hold back some of the income they receive in an effort to smooth out the monthly distributions. They may even top up the distributions with some return of capital when necessary.” Vanguard doesn’t smooth out the distributions, it pays them out as they receive them, which means dividends will fluctuate from month to month in most cases.

      My guess is that the yield will increase a bit over time. In this portfolio I came up with, the focus isn’t on dividends, so I didn’t put much thought into the dividend income.

      You are right about my portfolio dividend yield. It’s currently sitting around 3.17% with a yield on cost around 4.04%.

  • Erich

    Could not agree more that couch potato style index investing is a great alternative to DGI. I’m forced to hold company contributions and RRSP matching in a locked-in account with only mutual funds as options, so I also use couch-potato style index fund management there. I see it as another form of diversification, holding based on a different investment method. I can always buy up DG stocks once I’m finally allowed to take money out of the locked-in “pension”.

  • The ETFs you are using are hard to track compared to the market.

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