Couch potato's guide to getting rich
by Kathy Kristof for CBS MoneyWatch.com
Maybe it's because the country was raised on the Protestant work ethic. Or maybe it's that our mother's words still ring in our heads: "If you don't work hard, you'll never amount to much." Whatever the reason, Americans think they need to work hard to make money and that's not always true.
Sure, you've got to show up and diligently toil at the office. But when you save and invest, you're better off being a couch potato. The lazy approach to portfolio management wins over "hard work" pretty much every time.
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How much does it pay to be lazy? A conservative estimate is that it would pay an average investor somewhere north of $250,000. That's right. You gain a quarter of a million dollars by doing less - ideally almost nothing. (I'll explain how in a minute.)
The first time I heard this concept, it was at an investment conference back in the 1980s and Jack Bogle, the founder of Vanguard Investments, was speaking. He talked about his academic research that proved that virtually no one could consistently beat the market over long stretches (like the 40 years we have to invest for retirement). The best you could hope for was to meet the market, which gave you returns that weren't half bad.
The answer, he said, was invest in a broad swath of stocks and bonds through low-cost index funds and forget about your portfolio. Spend your time living your life instead of researching stocks and bonds. That's much more fun than sweating over investments anyway.
A few years later, at another investment conference, I discovered Terrance Odean, a Berkeley professor who proved Bogle's theory by coming at it another way. The more you trade, the more you lose, Odean discovered by examining the real-life portfolios and trading patterns of thousands of investors. His paper, Boys Will Be Boys, is a must-read for those who think they're going to outsmart the stock market.
But I was reminded of the wisdom of the lazy approach this week by The Oblivious Investor, a neat little blog full of common sense advice. I had gone to read a post about paying for investment advice, but got distracted. (Does the web make everybody ADD, or is it just me?)The next thing I knew, I was reading a wonderful little piece about 8 Lazy Investment Portfolios. (In truth, the post is titled 8 Lazy ETF Portfolios, but that was so Wall Street-speak that I had to edit. ETF is short for Exchange Traded Fund and the only magic about this type of mutual fund is that they're super-low cost.)
In the post, the Oblivious Investor outlines the simple portfolios recommended by 8 lauded experts, including MoneyWatch's own Allan Roth, author of How a Second-Grader Beats Wall Street, and Steve Vernon, author of Live Long and Prosper.
All of these portfolios are low-cost; tinker-free plans. You buy them and leave them alone.
I even included a similar plan in the update of my book, Investing 101, called "The Lazy Man's Portfolio Planner." The only difference: You plug your own numbers into my portfolio planner to match your age and circumstances, so your tinker-free portfolio will meet your cash needs and suit your personality. That, presumably, will help you leave your stocks alone during volatile times like these, which could save you a fortune over the long run.
So how does being lazy pay you money? If you read Odean's research, you'll find that frequent trading costs you roughly 2.65 percentage points in annual investment returns. That means that, instead of earning an average of, say, 8 or 9% on a portfolio that you buy and leave alone, you'd earn between 5.35% and 6.35% by tinkering with it.
To see how that affects you in dollars and sense, we turn to "simple savings calculator" at BankRate.com. If we assume that you start investing $150 a month at age 25 and continue to contribute that same amount for the next 40 years, you'd end up with a portfolio worth $527,292 if you're lazy enough to leave it alone and earn the average return of a diversified portfolio of about 8%. But, if you tinkered around - which triggers taxes and trading costs - you'd only earn an average of 5.35%, according to Odean's analysis. That would leave you with $252,229 - some $275,063 less.
If you assume higher rates of return on your investments, or if you invest more on a monthly basis, the cost of tinkering becomes even more onerous. Let's say you invest $250 a month and earn 9% on average. At retirement, the couch potato's portfolio would be worth $1.179 million. The tinkerer's portfolio (which earned just 6.35% on average) is worth $550,945 - an astounding $628,412 less.
The only tinkering you should do with your portfolio is to "rebalance" once a year. What that means is you look at the percentage of your assets that you have in each asset class - stocks, bonds, cash, etc. - and make sure that matches with the percentage that you think you should have based on your age, assets and goals. (If you have a planner, they'll help with the numbers or you could do the worksheets in my Lazy Person's Portfolio Planner - Chapter 13 of Investing 101 - to get the right percentages.)
But you just heard somebody say "This is a trader's market! Buy and hold is dead!" Find out what they're selling. It's not impartial investment advice. Those who have nothing to sell you - the professors, the pundits and the cynical journalists like me - are going to tell you that you'll make more in the investment world when you're lazy than you ever could by trying to outsmart Wall Street.
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