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Jim Maroney

:: Mutual fund management fees add to the paid of steep losses endured by most investors

:: During the past several weeks I’ve been reviewing various costs associated with mutual fund ownership – costs that can arise at the time of purchase and ongoing costs during the period of ownership. Some of these costs are paid directly by the investor whereas others are borne by the fund. In the end result, though, it really doesn’t matter who pays the cost of owning and managing a mutual fund – it’s always the investor who ultimately bucks up by accepting a lower return on investment than would otherwise be the case.

This fact wasn’t made any more tolerable by looking at the mutual fund section in this past Monday’s Financial Post. The front page of this section contained two charts that pretty much summarized the mutual fund investment experience during this past year.

The first chart dealt with the performance of 35 different asset groups (e.g., precious metals, Canadian bonds, US equity and so on). Of the 35 asset groups, only 10 managed to achieve positive one-year returns. Only 3 of these 10 select asset groups achieved double-digit annual returns.

Turning to the negative achievers, 14 of the 25 loser asset groups realized annual losses of 10 per cent or more with the futility award going to the science and technology group that clocked an annual loss of 43.16 per cent.

The second chart in the Financial Post looked at individual mutual funds where the performance wasn’t a whole lot better. Of the 33 largest funds in the land, only 15 managed to achieve a positive return but there wasn’t one double-digit achiever among them. In fact, a simple average of the positive-performing funds reveals an annual return of 3.26 per cent. Evidently losses were easier to achieve given the simple average of the negatively performing funds was minus 9.85 per cent.

Remember that owners of these funds have paid, above and beyond their initial investment, for this experience. Mutual fund managers have continued to receive management fees in good times and in bad.

Now to be perfectly fair, with September 11 and all, this past year has been one of the most difficult years in investment history. Who’s to say that positive returns might have been lower or losses higher without the wisdom of mutual fund managers? Not I that’s for sure.

But is there a better alternative to mutual funds for the thick-skinned among us that still have the stomach for stock market investing? Indeed there is according to Scott Burns who writes for the Dallas News (www.dallasnews.com/business/scottburns for the computer literate). Back in 1991 Burns wrote an article describing what he referred to as the Couch Potato Portfolio – “a surefire formula to invest your money, enjoy a return that will put you in the top half of all professional investors, but expend virtually no effort or thought”. Hmm. No effort or thought – that’s got a certain appeal I’d say.

Anyway the gist of the Couch Potato Portfolio (CP for short) is to invest half of your money in a low-cost index that mimics the S&P 500 index and the remaining half in a low-cost bond fund that mimics the Shearson Lehman index for intermediate maturity bonds. The basic idea is that at the end of the year you simply determine the total value of your investment, divide by two and rebalance so that split between the two investments remains at 50/50. So, in essence, if you can divide by 2 you can manage your own CP portfolio.

Analyzing data from 1993 back to 1971, Burns determined that the CP would have achieved annual rate of return equal to 10.29 per cent – slightly less than the S&P 500 (10.56) over this same period. Furthermore, in achieving this return the CP experienced fewer ups and downs during the review period than all common stock mutual funds with ten-year track records.

Since Burns first described the CP, variations have sprung up including the Tilted Couch Potato and one for the truly lazy among us, the Comatose Couch Potato. In fact, there’s even a Canadian version of the Couch Potato that’s a little more elaborate.

The Canadian version requires investors to purchase three low-cost index funds: Canadian bond index fund, a S&P 500 index fund and a TSX index fund. A more detailed description of the Canadian Couch Potato can be found at the moneysense.ca website by drilling down through the “funds” tab.

There you’ll find a chart tracking a $100 investment on January 1, 1976 in a Couch Potato Portfolio versus a Canadian Stock Index. At the end of last month, July 2002 when the market was in bad shape, the Couch Potato investor would have $2,030.68 compared to the Canadian Stock Index balance of $1,315.83.

Yet another chart shows that on a year-by-year basis, the Couch Potato achieved superior returns in comparison to the Canadian Stock Index in 14 of the 26 years covered.

According to a website article by Ian McGugan, Editor of Moneysense Magazine, the Couch Potato works so well because it diversifies your investments, keeps expenses low by using low-cost index funds and it makes use of annual rebalancing forcing investors to sell high and buy low.

So are there alternatives to mutual fund investing and its inherently high cost? Evidently, the answer is yes and best of all, with a name like Couch Potato, the idea should have universal appeal.

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Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney
CA Canadian Chartered Accountant with Brown, Andrews & Maroney in Maple Ridge, BC, Canada

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