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The Muscular Portfolios Newsletter — No. 42 — Feb. 13, 2022
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Lazy Portfolios equal lousy performance
 By Brian Livingston
Fifteen years of tracking by two respected data-analysis authorities show that Lazy Portfolios — which never change their investing positions — far underperform the S&P 500. By comparison, Muscular Portfolios handily outdo the index.
Lazy Portfolios’ poor performance would be acceptable if these strategies protected investors from the stress of severe losses. But the latest numbers show that Lazy Portfolios hit savers with almost the same terrible level of crashes as the volatile S&P 500 itself.
Lazy Portfolios consist of five or more index funds that various financial gurus tell investors to hold in static, unchanging proportions. The problem is that Lazy Portfolios ignore what’s known as the momentum factor. This is a well-understood feature of markets that has been proven in hundreds of scientific studies since the 1990s.
By contrast, Muscular Portfolios take full advantage of momentum. This feature of markets helps Muscular Portfolios determine which index funds have the best statistical likelihood of doing well in the coming month. We’ll see the numbers below.
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Figure 1. Lazy Portfolios are nine of the many investing strategies that MyPlanIQ, a data provider, has tracked for decades. Including dividends, the S&P 500 turned $100 into $449 in the past 15 years. Lazy Portfolios turned $100 into only $193 to $323. Worse, they subjected investors to intolerable 35% to 49% drawdowns during market crashes. Source: MyPlanIQ’s Lazy Portfolio strategy-detail pages.
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MyPlanIQ, a principal source of data on Lazy Portfolios, uses the prices of actual mutual funds and ETFs (exchange-traded funds) to compute the returns of investors who faithfully followed each strategy’s rules. Using actual fund prices automatically subtracts fees and other expenses.
The graph in Figure 1 shows that Lazy Portfolios fail to give investors anything like the S&P 500’s return. But these passive strategies still pound investors’ emotions with gut-wrenching crashes every few years.
Let’s say you started on Jan. 1, 2007, with personal savings of $100,000 in a 401(k) or similar tax-deferred plan:
- If you’d invested that money in an S&P 500 index fund (such as Vanguard’s VFIAX), 15 years later you’d have had $449,000 — almost half a million dollars. That might have been enough to enable you to quit your job and live off your savings. But most people can’t tolerate holding all their savings in the S&P 500, because of its heart-rending crashes. For example, the index was down –55% in the global financial crisis (2007–2009) and down –34% in the pandemic shock (2020).
- If you’d followed a Lazy Portfolio instead, you’d end up with $126,000 to $256,000 less than the S&P 500 delivered. Your nest egg would contain no more than $323,000 (with the Unconventional Portfolio) or as little as $193,000 (with the so-called Ultimate Portfolio).
- Would missing one-quarter to one-half of your expected nest egg have changed whether you could afford to quit your job? You bet it would! That’s a lot fewer dollars to live on. And after you resigned, your money would grow at a much slower rate if you continued to follow a Lazy Portfolio rather than the S&P 500.
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Muscular Portfolios top the index by keeping losses small
The returns of Muscular Portfolios have been tracked back to 2007 by the data-analysis firm ETFScreen. Like MyPlanIQ, ETFScreen also uses the prices of actual funds.
The book Muscular Portfolios defines two main strategies: the Mama Bear Portfolio and the Papa Bear Portfolio. Their results are shown in Figure 2.
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Figure 2. The two Muscular Portfolios turned $100 into $486 and $523. That gave you 8% to 16.5% more dollars than the S&P 500’s gain. Despite this superior record, the Papa and Mama kept your drawdowns — even on their worst days in 2007–2021 — to only 19.97% and 23.21%, respectively. In the same period, Lazy Portfolios and the S&P 500 crashed horribly: 35.5% to 55.3%. Source: ETFScreen.
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Muscular Portfolios are designed to never subject investors to losses greater than 25% between any two monthly statements. Studies show that individuals begin liquidating their assets, harming their performance, after their accounts lose more than 25%.
If we measure drawdowns between monthly financial statements — the way the book calculates the available monthly historical data — the Papa was down in 2007–2021 only 17.72% on Jan. 31, 2016. The Mama was down only 16.15% on Mar. 31, 2020. Ideally, investors should check the market only once a month, not every day. This avoids emotional reactions to daily swings and has been proven in research to keep investors from making sudden moves that harm their portfolios’ performances.
What’s the secret? Muscular Portfolios usually outperform the index only during bear markets and corrections. The portfolios typically underperform the S&P 500 during bull markets. Fortunately for us, that combination succeeds — mathematically — to generate for investors more money than the index over complete bear-bull market cycles, which average eight years in length. (The Vanguard Group found that 97% of all market-beating portfolios lag the market for periods of five years or more, as I explained in a 2019 StockCharts column.)
Investing strategies usually lose their effectiveness after they’ve been published in academic journals. But I specifically selected the book’s two Muscular Portfolios because of their timeless qualities. Their original designers had already worked with thousands of investors using real money for decades.
Steve LeCompte of CXO Advisory Group has reported the results of a strategy similar to the Mama Bear since June 2006. Mebane Faber, the CIO of Cambria Investment Management, publicly disclosed a white paper similar to the Papa Bear in May 2006.
The S&P 500 is just a number. It’s easy for simple, classic investment approaches to surpass the index. By contrast, complex formulas fail because they are locked into a past history that will never repeat exactly. They don’t adapt to future market conditions.
As StockCharts statistics show, well-understood approaches — such as the Vanguard Total Market Index (VTI) and the Dow Jones Industrial Average (DIA) — routinely surpass the S&P 500 for decades at a time. You can, too.
The dramatic results in Figure 2 are especially notable because the formulas for the Mama and Papa are fully disclosed. The ETFs that are statistically the most likely to rise in the next month are posted completely free of charge on Muscular Portfolios’ Mama page and Papa page. There are no hidden rules or closed systems.
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MarketWatch’s numbers closely agree with MyPlanIQ’s
For more than 15 years, the financial news site MarketWatch has tracked the performance of Lazy Portfolios using many of the same funds that MyPlanIQ and ETFScreen do. MarketWatch provides no historical database. But I’ve preserved the website’s performance numbers going back to 2005. (See Figure 3-2 of Muscular Portfolios.)
Updated once a day, the site’s performance table — shown here in Figure 3 — displays annualized returns back only 10 years. But regardless of the time period examined, MarketWatch’s numbers match MyPlanIQ’s within an error margin of less than one percentage point.
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Figure 3. MarketWatch’s table documents Lazy Portfolios’ long-term underperformance. The right-hand column reports 16.55% annualized for the S&P 500, but only 7.13% to 9.75% for Lazy Portfolios. In this screen cap, the rows are sorted by 10-year performance, omitting three “starter portfolios” with four or fewer assets, which MyPlanIQ does not track. Source: MarketWatch’s Lazy Portfolio page as of Jan. 1, 2022.
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The concept of portfolios that investors would set up once — and then never have to change — gained a boost with the publication in 2004 of The Lazy Person’s Guide to Investing. The book’s author, Paul B. Farrell, defined Lazy Portfolios as “the kind of low-maintenance portfolios most Main Street investors really want.”
MarketWatch’s Lazy Portfolios intro is a bit out of date now — Farrell retired in 2015 from his role as a columnist there — but a computer faithfully continues to update the strategies’ returns each day based on their original rules.
Three portfolios that appear in MarketWatch’s numbers are not shown in Figure 3. They are “starter portfolios” that hold fewer than five funds. That’s not enough diversification for them to qualify as true “asset allocation portfolios,” so they are not tracked by MyPlanIQ. Their 10-year annualized returns, according to MarketWatch, are 8.95% (Margaritaville), 10.41% (No-Brainer), and 12.25% (Second Grader’s Starter Portfolio).
Ironically, all three of these “super basic” portfolios outperformed the allocations called Ultimate and Cowards (which Farrell refers to as Dr. Bernstein’s Smart Money).
The following are the Lazy Portfolios that MarketWatch or MyPlanIQ (or both) track. Each line provides a link to MyPlanIQ’s strategy-detail page for more information:
• The Coffeehouse Portfolio by financial planner Bill Schultheis (info)
• Dr. Bernstein’s Cowards Portfolio, aka Smart Money (info)
• The Aronson Family Taxable Portfolio by investment advisor Ted Aronson (info)
• The Gone Fishin’ Portfolio by investment strategist Alexander Green (info)
• The Ideal Index Portfolio by investment advisor Frank Armstrong III (info)
• The Nano Portfolio by journalist John Wasik (info)
• The 7Twelve Portfolio by professor Craig Israelsen (info)
• The Ultimate Buy-and-Hold Portfolio by wealth manager Paul Merriman (info)
• The Unconventional Success Portfolio by Yale CIO David Swenson (info)
On MyPlanIQ’s information pages, annual returns are shown in the More Analytics section. Monthly and daily historical data downloads are in the Advanced Options section. (A paid registration is required: $19.95/mo. after a one-month free trial.) Note: I’ve been a paid subscriber to MyPlanIQ for several years.
Any two or more portfolios that MyPlanIQ tracks can be examined side-by-side using the site’s comparison tool.
MyPlanIQ does not track Muscular Portfolios, offering instead its own “tactical asset allocation” service to those with a paid registration.
To see monthly returns for Muscular Portfolios (updated after every market day), visit ETFScreen’s Mama Bear and Papa Bear pages.
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Farrell has an open mind, but not everyone does
When Muscular Portfolios came out in 2018, I sent a copy to Farrell at his home in California. After reading the book, he sent me a quote and authorized me to use it:
- “Muscular Portfolios is the next evolution of Lazy Portfolios — a must-have in every investor’s library.”
Unfortunately, since the book had already been printed, it was too late or I’d have included his statement right on the cover. But Farrell’s intellectual honesty — the willingness to accept new proof — is admirable.
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Other advocates of Lazy Portfolios may never embrace evidence-based investing. In the 2012 book The Half-Life of Facts, Harvard mathematician Samuel Arbesman quotes a well-known saying among physicians:
- “It takes 50 years to get a wrong idea out of medicine, and 100 years a right one into medicine.”
What it is, exactly, about Lazy Portfolios that makes them perform so poorly? The answer is that Lazy Portfolio promoters use only the first three out of four principles in the well-known Fama-French-Carhart four-factor model.
That framework — which was published in 1997 and later helped Fama win the Nobel Prize in Economics — asserted that some assets go up in price more than others for four reasons:
- The market factor. Securities that are correlated with an exchange tend to rise in price when that market’s index goes up. The fact that volatile stocks rise more than risk-free, short-term bonds is solid. It’s often called the “equity risk premium,” as described in an Investopedia article.
- The size factor. Small companies were thought to rise in price faster than large companies. However, this belief was debunked in 1999 in a Journal of Finance article. It showed that errors in the original database were the source of the false assumption.
- The value factor. Companies with a low stock price as a ratio of their book value (called “price-to-book”) were thought to deliver more gains than other companies. This rule, too, has been proven to be unreliable. As former World Bank/IMF consultant Andrew Ang explained in his 2014 book Asset Management: “The bull market of the 1990s? The economy was booming, but value was killed.”
- The momentum factor. Assets that have gone up in price during the past 3 to 12 months have a statistical tendency to continue to go up for the next 30 days or more. This finding has been reconfirmed in hundreds of studies. A 2014 Fama-French academic paper that explored other factors stated: “All models that do not include a momentum factor fare poorly.”
Lazy Portfolios completely ignore the momentum factor. Most Lazy Portfolios were announced after publication of the four-factor model. But these much-publicized strategies failed to include any method for your nest egg to adapt to changing markets.
Unless a portfolio makes gradual course corrections every month or two — as Muscular Portfolios do — there’s no way an asset-allocation formula can deliver market-like returns without crazy-making crashes every 10 years or so.
If value stocks are going up, a Muscular Portfolio will tilt toward value stocks. If small companies are going up, the portfolio will tilt toward small companies. If neither is true, the portfolio can hold large-cap stocks, emerging economies, real estate, commodities, or bonds. You never need guesswork or in-and-out “market timing.” The technical name for gradually tilting a portfolio is asset rotation.
The latest academic research shows that the momentum factor continues to exist — despite the fact that it’s been known for decades — because “investors underreact to information that arrives gradually,” such as returns over a period of months. Wealth manager Wesley Gray, PhD, explains the behavioral psychology behind this in a recent literature review.
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Fortunately, you don’t need to know anything about the four-factor model. The facts speak for themselves.
Lazy Portfolios have poor performances in real-world markets with actual money. Muscular Portfolios, a clear step up, extract for you as much gain as the global markets can deliver. Checking once a month to ensure that your account holds the recommended ETFs automatically leads you gradually into assets that are going up, not crashing.
As if drawdown avoidance and great performance was not enough, the Papa Bear and Mama Bear instructions are provided absolutely free of charge at the Muscular Portfolios and ETFScreen websites.
Echoing Arbesman, it may take 100 years for the right principles to be accepted by the current promoters of Lazy Portfolios. But in the meantime, you can take advantage of Muscular Portfolios to maximize your long-term gains. Save the money you might have paid in fees to financial “advisers.”
For the scientific background on all of the above, please see the detailed explanation in the Bonus Chapter of Muscular Portfolios.
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Free stuff you might enjoy
 If you’ve read this far, you deserve a reward!
For a limited time, you can download a free PDF that combines this newsletter’s Figures 1 and 2 into a single graph. The image shows the 15-year performances of Muscular Portfolios, Lazy Portfolios, and the S&P 500 — all on a single page.
Print it for inspiration, share it as an educational aid, or post it as you like.
Use this download link to get it
Thanks for your support!
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