Scott Burns Interview: Part 2

Here is part two of my interview with Scott Burns, the newspaper columnist and Chief Investment Strategist at AssetBuilder who created the original Couch Potato portfolio more than 20 years ago. You can read part one here.

You’ve said that anyone who can fog a mirror can be an index investor, but as I’m sure you have found, even people who accept the academic arguments often cannot bring themselves to trust the markets.

SB: Absolutely. There are basically two issues here. First, there are the people who say, “I like the Couch Potato approach, but can’t I tweak it a little bit?” The moment they start doing that they are saying that they can forecast the market. They think it’s just tweaking, but they are starting down a road that ends in trying to foretell the future. I think there can be enormous flexibility in an index approach, don’t get me wrong. But when people come with the mindset of liking the Couch Potato but wanting to tweak it, the tweaks get larger and larger and ultimately they become fortune tellers.

The other issue is trust. More people today are wondering about the end of the world, and more people today are frozen at the switch, not knowing where to invest at all. I have never seen a more paralyzed market for the average investor. They just want to go somewhere and hide. I don’t know what we can do to restore things. We had this collapse [in 2008], and nothing has happened to the industry that brought it on. The reforms that were made were not very powerful, and there are efforts every day to lift those restrictions and allow people to go on gambling in the financial sector with public money.

Given all of these problems and the lack of any obvious solution in the short run, how do you make the argument that index investing is still relevant? How do you answer the critics who say that “blind faith” in the market doesn’t work anymore?

SB: There are multiple answers to that. Let’s start with the people at the extreme who are predicting utter disaster: that the dollar will disappear in a puff of smoke, or that we will be carrying dollars around in wheelbarrows. That event has been predicted since the 1940s, and it has been wrong for all of that time. It may come to pass, but you can’t run a portfolio or a financial plan based on black swan events, which by definition are unpredictable. As appealing as the whole black swan idea is, it is fundamentally not workable, because the other 99% of the time you’re going to be earning at least a reasonable return in conventional investments.

The other side of it is that we live in a world of unintended consequences. We never know exactly what the consequences of an action will be, but it is usually a surprise. Inventions come from out of the blue. We still can’t predict. So what is the only thing we can do? We can be as diversified as possible. And in that respect, the financial services industry has actually helped us, because since the start of the Couch Potato, when you could basically only invest in two asset classes, you can now get very broad diversification. The best we can do is diversify and hope that some asset classes will compensate for losses in the others.

One of my favourite model portfolios is called Six Ways from Sunday. It captures all of the basic asset classes without taking slices of value and growth: it’s two-thirds equities, and one-third fixed income. It’s simple, it uses the lowest cost instruments available, and you have complete representation of the major asset classes in the world. It’s not perfect, but if you’re after perfect you’re going to fail. The Couch Potato is about being good enough.

Index investors have far more opportunities today than they did five or six years ago, let alone 20 years ago. But I wonder if you agree that the huge number of choices that investors have today can overwhelm them and cause them to make poor decisions.

SB: You’ve put your finger right on it: Wall Street is creating yet another smokescreen that is highly profitable for them. There is a proliferation of funds that are entirely speculative vehicles. If you are buying an ETF that is premised on tripling the gain of the S&P 500, then you’re a speculator. If you are trying to make money with an ETF that rises in value when the world ends, you’re also a speculator. You’re not an investor. It’s hard for many people to get to the basic idea of simple.

The biggest problem isn’t necessarily product proliferation: I think the biggest issue we are facing now is the lack of income. It doesn’t matter where you go, in what asset class, there is essentially no income. But this is probably a great time to be an accumulator, even if it doesn’t feel that way. You know, 20 years from now people who are putting money in retirement plans today are going to feel just as good as the people who kept doing so throughout the 1970s. They will have accumulated assets that eventually take off, and they will do well.