Using the dogs of the dow strategy to grow your portfolio
There are a couple of strategies an investor can use when putting together a portfolio of equities. The easiest is to simply build a portfolio of index funds that invests in an appropriate percentage of stocks and bonds depending on the desired asset allocation.
The hardest is picking a number of individual stocks and bonds using fundamentals. And technical analysis to identify companies that might be solid investments for the short or long term, depending on your approach.
Right in the middle in terms of ease is mechanical investment strategies that select stocks for your portfolio based on a proven method of ranking them from the best investments to the worst.
One of the most well known mechanical investment strategies is called the Dogs of the Dow.
What is a Mechanical Investing Strategy?
A mechanical investing strategy buys and sells stock based on pre-defined criteria. There are a number of different types of mechanical investing strategies. However, most of them involve a way of ranking stocks based on specific factors.
For example, one strategy could identify the stocks with the best fundamentals based on earnings growth and momentum and rank them according to which ones are the strongest based on those two factors. With that list, the investor would then buy the top stocks and hold them until it was time to rebalance, typically on a weekly, monthly, quarterly, or yearly basis.
A critical component of mechanical investing is the concept of backtesting. In order to identify the best criteria for a strategy. The investor will use historical data and test the various criteria against that data to see how the strategy would have performed in the past. That whole process is complicated and beyond the scope of this article.
However, the Dogs of the Dow strategy has done all this work for you and is a mechanical strategy that can be put into practice right away.
What are the Dogs of the Dow Strategy?
The Dogs of the Dow Strategy, or Dogs, is a mechanical investing method that was introduced to investors by Michael O’Higgins in the book, Beating the Dow [include affiliate link?]. In this book, he outlined the backtesting data, method, and how to invest using the Dow strategy.
The concept is based on looking at some of the largest and most well-known stocks in the United States and adding on a valuation perspective based on dividend yield. Well known companies like Coca-Cola, Apple, and Wal-Mart are a few of the companies in the Dow.
The rational is that the stocks in the Dow that have a higher dividend yield are cheaper than those with lower dividend yields. These higher dividend-yielding stocks present buying opportunities.
In normal circumstances, buying only the highest yielding stocks can be a poor strategy as the high dividend yields can signal a company with problems. However, because the Dogs strategy focuses on the Dow 30, which are large and well-established companies. The strategy seems to work overtime as those companies ebb and flow through their business cycles.
How to Select the Top Stocks?
In order to run the strategy, there are only a few steps the investor needs to do. Here are the step-by-step instructions on how to get the list of stocks to buy:
- Identify the dividend yield for all thirty of the Dow stocks.
- Rank all thirty of these Dow stocks from the highest dividend yield to the lowest dividend yield.
- Buy the top ten highest yielding dividend stocks from the list.
- Hold those ten stocks for one year, and then repeat the process. If a stock is no longer in the top ten, sell it, and add the stock that is now part of the ten highest yielding stocks.
That is all there is to it. If you are not interested in doing this work on your own, there are numerous resources on the web that will run the process for you and tell you exactly which ten stocks have the highest yield today.
How Has the Dogs Strategy Performed?
Now that you know how the strategy works, let’s look at its performance over the years. The site, Dogs of the Dow has been keeping track of the performance of the strategy for a number of years. Here is their most recent performance table, which includes an additional strategy called the Small Dogs of the Dow. That strategy simply buys the five lowest-priced stocks in the list of ten high dividend yielders.
As you can see, since 2000 the Dogs strategy has beat the S&P 500 by 2.1%. That is a large difference. A $10,000 investment in the S&P 500 would have become $24,647 while an investment in the Dogs would have become $33,755. The Dogs strategy added $9,108 to the investor’s portfolio.
As a strategy, it does not get much easier to invest than using a mechanical investing strategy like the Dogs of the Dow. The performance is strong, and if used consistently it definitely has the potential to improve your investment performance.
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