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The bull market is back. That’s the view of the hot potato portfolio, which recently went all-in on U.S. stocks.

The big move prompted me to check on the portfolio and its sister the passive potato portfolio. I last visited them in September when the markets were relatively calm before the COVID-19 pandemic. Let’s see how they’ve held up.

I’ll start with the passive potato portfolio, which offers hearty fare.

It represents a good option for most investors and has a solid track record. (It can also be easily modified to lean more heavily toward stocks, or bonds, depending on an investor’s risk tolerance.)

The passive portfolio invests an equal amount of money in four major asset classes including Canadian bonds, Canadian stocks, U.S. stocks and international stocks. The idea is to take a relatively hands-off approach to the market while minimizing costs.

The portfolio cooked up average annual gains of 9.6 per cent from the end of 1980 to the end of May, 2020. Those are fine results for such a simple approach. (All of the returns herein are based on month-end data and the gains of the FTSE Canada Universe Bond Index, the S&P/TSX Composite Index, the S&P 500 and the MSCI EAFE Index. They include reinvested distributions and assume monthly rebalancing, but they do not include fees, taxes, commissions or other trading frictions.)

The hot potato follows a much more aggressive strategy and it is not suitable for many investors. But it is easy to describe. Each month it moves all of its money into the single index (of the four used by the passive portfolio) that gained the most over the prior 12 months.

As a result, the hot potato portfolio trades fairly frequently in practice. It swapped indexes 1.7 times a year, on average, from the end of 1980 through May, 2020.

The extra effort paid off in the form of sizzling returns because the hot potato portfolio fried up average annual returns of 15.4 per cent from the end of 1980 to the end of May, 2020. It surpassed the passive potato portfolio by an average of 5.8 percentage points a year. You can see the return history of both portfolios in the accompanying graph.

The hot potato’s big returns were achieved, in part, by sidestepping some of the crashes that caused investors heartburn over the past few decades.

For instance, the passive potato portfolio was mashed after the internet bubble peaked in 2000 when it fell 29 per cent. It was diced in the financial crisis of 2008 when it tumbled 31 per cent.

The hot potato portfolio fared better, but it was still singed in those periods. It lost 21 per cent after the internet bubble burst. It fell 10 per cent in 2008 from its 2007 highs and fully recovered by the summer of 2009 thanks to a switch to bonds.

In the early 2020 crash, the passive portfolio fell 13 per cent from the top in January to the bottom in March while the hot potato portfolio declined 14 per cent (based on month-end data). The hot potato failed to dodge the worst of it this time owing to the speed of the 2020 decline.

But the markets bounced off their lows and, by the end of May, the S&P 500 sported gains of 15 per cent over the prior year in Canadian dollar terms and 13 per cent in U.S. dollar terms. The big returns prompted the hot potato portfolio to jump out of bonds and into U.S. stocks at the end of May.

The bull market is back as far as the hot potato is concerned. I’ll be watching its progress this summer with interest while noshing on some PEI potato salad.

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.

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