Your Hot Potato questions answered

Readers had plenty to say about the spicy alternative to the Couch Potato strategy

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I highlighted an active approach to index investing in “Are you ready for the Hot Potato?“, which appeared in the April 2016 edition of MoneySense.  The article generated a lot of discussion and I’m going to address a few questions about it from readers today.

Q: How many times did you have to trade the holdings in the monthly rebalance?

A: As mentioned in the article, “the Global Hot Potato made an average of 1.7 large trades per year from 1981 through 2015.”  That is, one asset class was sold and another was purchased 1.7 times per year on average over the period.  Naturally, the exact number of swaps varied from year to year depending on market conditions.

Q: What are the actual names and symbols of the ETFs that were used?

A: All of the calculations were based on index data rather than specific exchange traded funds (ETFs) or index funds.  This was done for a couple of reasons.

First, we wanted to use as much data as possible and exchange traded funds are relative newcomers to the market.

Second, we wanted to keep a small speed bump in place to dissuade novice investors from jumping into the approach without giving it an appropriate amount of consideration.  As we warned in the article;

“The Hot Potato approach isn’t for everyone and should only be attempted by aggressive, seasoned investors. New investors should stick with the more conventional Couch Potato method, which encourages long holding periods. As always, for the best outcome, know your inner investor. Some people can handle a little heat—or a great deal of it. Others can’t stand even a touch of pepper. Pick the portfolio that’s right for you because your piece of mind will depend on it.”

Q: This sounds like buying high and selling low.

A: It is a trend following approach that aims to buy high and sell higher.  As a result, it requires prompt and disciplined trading to avoid the “selling low” part of the equation.  But make no mistake about it, the method is not without risk.

Have more questions? Leave them in the comments below!


See Norm discuss portfolio strategy and more at our upcoming Invest for Success event. Learn more!


Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of April 19. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.


Name Price P/B P/E Earnings Yield Dividend Yield
Shaw (SJR.B) $23.42 2.11 13.46 7.43% 5.06%
National Bank (NA) $45.14 1.63 11.09 9.02% 4.79%
CIBC (CM) $99.81 1.9 11.04 9.06% 4.73%
BCE (BCE) $59.65 3.97 20.02 5.00% 4.58%
Bank of Nova Scotia (BNS) $64.33 1.52 11.11 9.00% 4.48%
TELUS (T) $40.25 3.12 17.58 5.69% 4.37%
Royal Bank (RY) $78.34 1.85 11.75 8.51% 4.14%
Bank of Montreal (BMO) $81.65 1.37 12.15 8.23% 4.12%
Power (POW) $30.34 1.08 7.87 12.71% 4.10%
Agrium (AGU) $110.27 1.83 12.57 7.95% 4.02%

Source: Bloomberg, April 19, 2016

Notes

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

Required Reading

You can’t beat all the chimps

“The fact of the matter is that even a random number generator can, and will, outperform practically all mutual funds. Such random strategies may seem like a joke, and perhaps they are, but if a joke can outperform industry professionals we have to stop and ask some hard questions.”

 

2 comments on “Your Hot Potato questions answered

  1. Love your work, Norm! Fascinated with the Hot Potato and the fact that it has been such a great performer historically. Two questions:

    1) Were any other rebalancing schemes tested? Biweekly, bimonthly, quarterly, etc. I’m guessing a month works best to the minimize number of trades per year yet still optimally capture the short term momentum effect.

    2) Glad you clarified that you used the index data to calculate performance and not the ETFs or index funds themselves. However, I’m not 100% sure how USD-CAD currency fluctuation is handled. I assume that the results presented uses the unhedged version of the indices to make the Hot Potato performance comparable to the original Couch Potato. However, when judging index performance to decide where to rebalance, I assume you want to look at the hedged version of the index (i.e. the S&P 500 total return rather than the S&P 500 total return in CAD). The though being that you only want to track the momentum of the index and not the unpredictable effects of CAD-USD fluctuation.

    Thanks,
    Adrian

    Reply

  2. I was attracted to your hot potato strategy and went about trying to implement it. Being a “couch potato” investor I didn’t want things to get complex. So I picked 3 ETFs to represent the 3 indexes (international, US, Canada) as well as a bond index. I set up a chart of the indexes in one of the free online stock charting tools and then tell it to show the last 12 months. If any of returns on indexes are above a “save haven” T-Bill equivalent rate, then I go all in on the ETF that mirrors that index. If the return is less than the safe rate, I go all in on fixed income.

    Is this a correct interpretation of the strategy? For example when I checked recently the returns on all the indexes were in negative territory, so I went into bonds.

    Reply

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