Investing in the stock market is hard work right, right? You need to spend hours reading company reports, monitoring technical charts while always keeping an eye on financial and economic news. And, of course, you need to monitor the market and your portfolio at all times, always looking out for the opportune time to buy and sell.
Actually you don’t have to do all of that, not if you don’t want to anyway. While many investors have built very successful careers as day traders, history has shown it is entirely possible to deliver solid – even potentially market-beating – returns using very simple strategies. Let’s take a look at one of the simplest of all – the Dogs of the Dow.
What are the Dogs of the Dow?
The term “Dogs of the Dow” was first coined by Michael B O’Higgins in his 1991 book Beating the Dow. The idea is that investing in stocks paying the highest dividend yields on the Dow Jones Industrial Average will yield better results than investing in the index as a whole. These stocks are called “dogs” because they tend to be among the least loved companies on the index; the reason they offer higher yields is often because they have performed relatively poorly over the past year.
Does investing in the Dogs yield results?
If you’d followed the strategy since 2009, you’d have beaten the Dow Jones in six out of those 10 years. That’s not bad at all for such a simple strategy, though the number falls to five out of 10 when you compare it to performance of the broader S&P 500 index. The strategy also tends to go through good patches and bad patches: for instance, it performed very poorly during the GFC, and in 2020 yielded -12.6%, compared to the Dow’s 7.2%, and the S&P 500’s 18.4%.
That poor 2020 performance means on a 10-year-basis, the Dogs strategy has underperformed against both indices, posting an average annual return of 9.2% versus 11.4% for the Dow and 12.3% for the S&P 500. Since 2000, the Dogs have underperformed against the other two indices slightly more than half the time, tending to underperform during crises in particular.
The Small Dogs of the Dow
This is a twist on the original Dogs of the Dow Strategy and requires the investor to buy only the five highest-dividend-paying stocks, rather than 10. You can think of this as a concentrated version of the original strategy and, according to proponents, this has proven even more effective over time, delivering an annualised return of 10% since 2000, compared to 9% for the original Dogs strategy and 7.5% for the Dow.
Why the Dogs strategy (sometimes) works:
There are two core theories at the heart of the Dogs of the Dow Strategy: firstly, that a stock with a higher dividend yield will have a better chance of beating the market than a stock that pays a lower yield.
The second is that the stocks on the Dogs list are likely there because they haven’t performed as strongly as others on the index (dividend yields rise as stock prices fall – so long as the amount the company is paying out remains the same) and may therefore be undervalued. Of course, the companies that make the list are often there for a reason and may well be facing challenges that won’t be resolved within a year. If they are really in trouble, they may also reduce their dividend, essentially blowing up the investment rationale.
However, the strategy is essentially a game of probabilities. It’s fairly likely that a few of the stocks will do poorly, but less likely that the majority of them will and the gains from the strongest performers will (hopefully) offset the weakness from others.
What about other indexes? Do they have Dogs as well?
Of course, every index, from the FTSE100 to the Hang Seng has its winners and losers, so you may be asking yourself if it’s possible to apply the Dogs strategy elsewhere. The answer is that, technically, yes you could, though it’s unlikely to work in the same way. The reason is that the Dow Jones Industrial Average (DJIA) is made up of just 30 very large companies with long track records and relatively dependable dividend streams.
What type of investor does the Dogs of the Dow strategy suit?
The Dogs of the Dow is inherently a conservative strategy, albeit perhaps a little riskier than investing in an index-wide ETF. It’s relatively simple to implement and doesn’t require any involvement from investors outside of the first and last days of the year. Having a portfolio centered on very large companies may reduce the risk of heavy losses – outside of a financial crisis anyway – though it may also limit potential returns and so may not be attractive to investors who are comfortable in taking on a higher degree of risk.
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