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John Heinzl (Kevin Van Paassen)
John Heinzl (Kevin Van Paassen)

Investor Clinic

A life of leisure with the Couch Potato method Add to ...

In our last column we looked at how mutual fund fees eat into returns. This week, we'll discuss a low-cost, low-stress alternative to owning a portfolio of mutual funds.

It goes by various names - the Lazy Man's portfolio, the Couch Potato portfolio, the All Weather portfolio - but the idea is the same in each case: You buy two or three index funds - four or five if you're really adventurous - and you put them away and forget about them.

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After a year, you spend a few minutes tweaking your portfolio, then go back to playing Guitar Hero or whatever. If you like the idea of saving time and money and beating the returns of most mutual funds, then the Lazy portfolio could be for you.

BET ON EVERY HORSE

The vast majority of actively managed funds trail the market. Why? Because they have to pay hefty salaries to their managers, who need cottages and boats and other toys. Mutual funds also face an array of expenses for things like marketing, administration and trading.

All of these costs drag down their returns. Even a few percentage points a year in fees can have a devastating impact on long-term returns.

That's where index funds come in. Instead of trying to beat the market, index funds try to be the market - by spreading their cash across every stock in an index. It's like betting on every horse in the race, which is easier than trying to pick a winner. Indexing is cheaper, too, because index funds don't have to pay a manager a big salary for delivering mediocre returns.

Result: More money stays where it belongs - in your pocket.

Skeptical? Here's what Warren Buffett has to say on the topic: "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Let's look at a few sample Lazy portfolios. Nothing is carved in stone here; investors can tweak them to suit their particular needs.

THE 'ULTRA' LAZY APPROACH

Entire books have been written on the subject of asset allocation, and some are quite good, according to people who have actually stayed awake while reading them. But our goal here is to keep things simple, right?

So, if you're really lazy, you could do worse than dividing your money equally between fixed income and equities.

As an example, say you've got $10,000. You could put $5,000 into an exchange-traded fund such as the iShares CDN Short Bond Index Fund, which tracks an index of high-quality government and corporate bonds and has a management expense ratio of just 0.25 per cent.

The other $5,000 could go into a low-cost equity index ETF such as the iShares CDN LargeCap 60 Index Fund, which tracks an index of 60 of the largest Canadian companies and has an MER of 0.17 per cent.

Depending on how stock and bond markets perform, you would then adjust the portfolio once a year - or quarterly if you're so inclined - to bring the equity and fixed-income components back to the 50-50 target.

LAZY WITH AGE

Want to get a bit fancier?

Some experts recommend a fixed-income allocation that's roughly equivalent to the investor's age. In other words, a 60-year-old would have 60 per cent of his or her money in bonds or guaranteed investment certificates, and the rest in equities, the idea being to reduce risk with age.

Applying this strategy to the Lazy portfolio is a snap. The investor would start with a fixed-income allocation matching his or her age, and the weighting would be increased annually in keeping with the moving targets. There's no need to get the targets exact; being in the ballpark is fine.

LOOKING ABROAD

Want a bit more diversification?

Because Canada's stock market is heavily weighted toward financial services, energy and commodities, many investors think it's wise to get exposure to international markets that offer a broader selection of such sectors as consumer products, health care and technology. Again, adapting the strategy is simple: Invest a predetermined percentage of the equity portion of the portfolio in ETFs that track the U.S. and international markets. The same rules of rebalancing apply: Once a year, buy or sell to bring the allocations back into line.

ETFs V. INDEX MUTUAL FUNDS

For investors who make regular contributions or rebalance quarterly, the commissions associated with buying and selling ETFs (which trade on an exchange like stocks) can outweigh the savings from the low MERs. In such cases, index mutual funds may be a better choice.

Index mutual funds are passive investments, so their fees - while higher than ETFs - are lower than those of actively managed mutual funds. What's more, there are (usually) no charges for buying and selling, which makes them appropriate for investors who sock away money on a regular basis. Just be sure to ask about any early redemption charges if you're planning to rebalance frequently.

Some of the lowest-cost index mutual funds are the e-Series units available online from TD Mutual Funds. TD's e-Series Canadian Index Fund, for instance, charges an MER of just 0.31 per cent.

DON'T JUST DO SOMETHING, SIT THERE

Just because you own a Lazy portfolio doesn't mean you'll be unfazed when all hell breaks loose on financial markets. But, by setting asset allocation targets and sticking to them, you'll be less tempted to buy and sell on emotion. And by keeping your emotions - and your costs - under control, you will have slain two of the biggest enemies an investor faces.

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