Couch Potato Portfolio VS. Talmud Portfolio | Medium Risk Long Term Investing

Have you got some money that you want to put to work? An inheritance, an insurance settlement, a large performance bonus from your job? Most people aren’t investing their savings because they don’t know how to do it safely.

They are mistaking investing for gambling. They think that successful investors are picking stocks and trading in and out of positions all day long. It turns out nothing could be further from the truth. All you really need is a properly designed portfolio, a consistent savings plan, and the time to let it grow.

In today’s video I’m gonna share two very old, but very effective portfolios that anyone can implement to compound their savings. So put down that newspaper, pull up a seat, and spend 10 minutes or so with me today and I promise that you will learn something useful!

TALMUD PORTFOLIO

“Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep by him in reserve.”
Babylonian Jewish Scholar

This quote came from the Talmud which is a collection of ancient babylonian texts used as set of guidelines for living a proper jewish life. It seems that even in ancient times intelligent investors understood the value of diversification.

Given its age, there are a lot of modern interpretations of the Talmud Portfolio but the one I’m going to use is made up of:

34% Total US Stock Market Fund (VTI)
33% Total US Real Estate Fund (VNQ)
33% Short Term US Treasuries (SHY)

There are 2 unbreakable, evergreen laws in investing:

Diversify ones portfolio as much as possible
Don’t buy overvalued assets

The Talmud tries to comply with these laws by grouping 3 asset classes that have traditionally, from time to time, been loosely correlated.

COUCH POTATO PORTFOLIO

The Couch Potato Portfolio was cread by Scott Burns, who was a columnist at the Dallas Morning News. This portfolio is:

50% Total US Stock Market (VTI)
50% Treasury Inflation Protected Securities (TIP)

This portfolio was created with retirees in mind as well as people who have received a windfall payout of some kind who want to invest the money but want a sophisticated portfolio to manage. This portfolio is for investors who want a mix of growth and wealth preservation.

EVALUATION

We are going to evaluate the 20 year period from 2001-2020. The annual return is 6% and 7%, which is frankly not very good. The Talmud took a historic beating with that 40% max drawdown and 23% single year loss thanks to the real estate crisis of 2008.

All in all, neither of these portfolios look very great over the last 20 years. But we need to consider the events that occurred during this time-frame, two historic market crashes and recessions. The Total Stock Market, which is typically the highest risk asset class only returned a little over 8% over this time.

To get an understanding of how our risk was, or wasn’t rewarded we need to look at the efficient frontier models.

Efficient Frontier – Talmud

Based on the asset classes in this portfolio it looks like the current allocation is perfect. We are right along the effienct frontier line. Its kind of rare that you run this model and see a portfolio sit directly on the line. You usually see plots below the line which indicate the portfolio is taking on far too muc risk for the return you are getting. In this case, based on the 3 asset classes we are invested in, unfortunately for this specific timeframe, 7.82% is the best return you would earn.

We’re gonna make a minor change to the allocation in a few minutes to improve the returns of this portfolio.

Efficient Frontier – Couch Potato

It looks like a similar story for the Couch Potato. Given the 2 asset classes we are using this 7% return is the best possible return we could have hoped for. Take a look in the upper right corner and see the US Stock Market. This portfolio got beaten badly by the all-stock portfolio, granted is also took multiple 50% losses too whereas this portfolio was fairly stable and consistent in its 7% returns.

Just like the Talmud, we are gonna change up both of these two portfolios slightly to dramatically improve both their returns and reduce the risk and/or losses.

CORRELATIONS

The key to building any balanced portfolio is to group asset classes that are loosely or negatively correlated with one another.

For the couch potato, note how the TIPs bonds have a slightly postiive correlation with US Stocks. We want to replace the TIPs bonds with Long Term Treasuries since we see that those have a negative correlation with US Stocks.

Same with the Talmud, the Short Term Treasuries also have a lesser correlation with Stocks but they also have terrible returns ~2% or so.

RE-EVALUATION (After Changing Cash Positions)

Note the massive improvement here. The final balances are far higher, annual returns are much higher, the worst year losses are lower, the max draw-downs are lower, The Sharpe Ratios are much better. Really the only downside is that we added a percentage to our standard deviation.

For the Couch Potato note how we’ve added 135 basis points to our returns. Going from 7% up to 8.35%.

For the Talmud, note how we’re several ticks below the efficient frontier which does mean that we are not getting the best possible return given the added risk but we’ve gone from a 7.82% return to 9.52%. That is a massive difference over the course of 20 years.

CONCLUSION

So what have we learned in today’s video? Well we learned that we can use the Couch Potato and Talmud portfolios to safely invest large sums of money easily. If we are feeling especially brave we can use asset class correlation analytics to optimize the cash/bond portion of these portfolios to squeeze out some much appreciated extra profits.

RESOURCES

M1 Finance App
Organize Stocks into Pies!

Portfolios Mentioned in this Post

Books

I Will Teach You To be Rich (Ramit Sethi)
A Random Walk Down Wall Street (Burton Malkiel)
The Simple Path to Wealth (JL Collins)

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