Does This Foolproof Strategy Actually Beat the Markets?
As the new year dawns, so does your opportunity to cash in on an easy long-term investment strategy.
Back in the early 1990s, Michael O’Higgins wrote about his theory for beating the markets. It’s extremely easy to use. We now know it as the “Dogs of the Dow” strategy.
At the start of the year, you simply take the 10 highest dividend-yielding members of the Dow Jones Industrial Average - allocating 10% of your portfolio to each position - and hold them for one year.
From there, you repeat and rebalance every year.
On the surface, it seems like a great strategy. It’s easy to understand.
But does it work?
What Else Besides Verizon, Pfizer and Merck?
The basic idea is that high-yield companies are at or near the bottom of their business cycles. Shares may have gotten beaten up the year before, but large cap blue chips don’t tend to change their dividend payouts.
Because of this, the higher yield indicates shares are undervalued... and those companies will likely outpace their index peers.
The Dow contains the bluest of blue chips. These companies are much more stable than other high-dividend yielders.
High yielders on the Dow don’t change much. For example, Verizon (NYSE: VZ) offers a 4.33% dividend yield. It’s been the highest-yielding Dow component since 2010.
Pfizer (NYSE: PFE) currently offers a dividend yield of 3.94%. It’s another of the highest-yielding Dow components. It has qualified for the Dogs of the Dow strategy since 2006.
Merck (NYSE: MRK) has a dividend yield of 3.19%. It’s part of the strategy for 2017 and has qualified for it every year since 2005, with the exception of 2008.
Like I said, the turnover rate has been low. An investor using this strategy would’ve replaced an average of 2.6, or basically 3, positions per year.
Let’s look at a table of the Dogs of the Dow each year, starting in 2007. The red represents positions held over from the year before...
So for 2017, you’d be replacing Procter & Gamble (NYSE: PG) and Wal-Mart (NYSE: WMT) with Boeing (NYSE: BA) and Coca-Cola (NYSE: KO) from the portfolio you started with in 2016.
From an original starting point in 2007, only Verizon and Pfizer remain. Altria (NYSE: MO) was removed from the index in 2008. General Motors (NYSE: GM) and Citigroup (NYSE: C) were dropped from it in 2009. AT&T (NYSE: T) was removed from the Dow in 2015.
Your original position in Merck would have been replaced by Home Depot (NYSE: HD) in 2008, with Merck then replacing Home Depot in 2009.
Now for the most important question... Does this strategy work?
Do the Dogs of the Dow outperform the index itself?
Like a lot of investing strategies or maxims, the original data for the Dogs of the Dow is promising. O’Higgins based his theory on the markets from 1973 to 1989. At that point, the Dogs of the Dow returned an average of 17.9% per year versus the rest of the Dow’s 11.1%.
Fast forward and the Dogs are coming off an extremely strong showing in 2016. They gained 16.1%, outperforming the Dow and the S&P 500.
But over the longer term, the results are mixed.
Think about this: Over the past 10 years, shares of Verizon have gained 56.32%. The Dow has gained 62.32%. Verizon has remained a prominent fixture in the strategy for a decade... but it hasn’t been beating the market over that time.
Since 2000, the Dogs of the Dow have outperformed the Dow and the S&P 500 just seven times. That’s a success rate of 41.2%. Plus, three of those years of outperformance were between 2000 and 2002 - two of those years where the Dogs didn’t lose as much as the markets. Only once in the past five years have the Dogs of the Dow outperformed the two indexes.
Admittedly, the Dogs of the Dow have beaten the Dow itself 10 times since 2000. That’s a success rate of 58.8%, or a little more than half the time. But the difference in gains is marginal.
Since 2000, the average annual gain of the Dogs of the Dow is 6.26% versus an average return of 5.39% on the Dow. Once you start including taxes and transaction fees - or management fees if investing in a mutual fund that follows the strategy - that difference narrows.
Here’s the real kicker...
If we break it down and count the number of years the Dogs of the Dow strategy significantly outperformed the markets - by 3% or more - we get a total of five years since 2000.
The number of years the Dogs of the Dow strategy significantly underperformed the market by 3% or more is four.
The final verdict is this: If we started with $10,000 invested in the Dogs of the Dow in 2000 and reinvested it back in each year, we’d have $21,811 today. That’s just 7.83% more than the $20,288 we’d have from reinvesting each year in the Dow.
Sometimes, a simple investing strategy is good. Some can even be very effective. But I don’t find any evidence of the Dogs of the Dow strategy performing better than a long-term Dividend Aristocrat approach.
The upside is you’re pulling from a very small pool of companies - just 30 from the Dow. It takes no work. The downside is... you’re pulling from a very small pool of companies and might not get the best opportunities for your money.
In short, there are far more profitable ways to invest in the months ahead. Stay tuned.
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