Is the Dogs of the Dow a legitimate investment strategy?

Let's be honest: The term "Dogs of the Dow" is not the most appealing, but it is a concept and investment strategy that is attracting the attention of contrarian investors. In recent years, markets have been extremely volatile, so injecting a degree of stability is likely to be welcomed in many ways. So, is the Dogs of the Dow strategy something to consider?

 

What is the Dogs of the Dow strategy?

 

As the name suggests, this investment strategy is based on the Dow Jones Industrial Average index, which consists of 30 large US companies. The index is price-weighted, as opposed to other indices such as the S&P 500 and the NASDAQ composite, which are market capitalisation-weighted.

 

The process itself is simple:-

 

· Identify the 10 Dow stocks with the highest dividend yield at the start of the calendar year

· Invest in these companies

· Hold the stocks for one year and then repeat the process

 

At face value, this seems too easy, but as the Dow index is based on large companies (which should, in theory, be financially secure), it is unlikely (but not out of the question) they would pass on their dividend. It's important to recognise that this is a contrarian investment strategy, as you are effectively buying stocks that are out of favour, as reflected by a relatively high yield compared to growth stocks.

 

Historical performance

 

The proof is in the pudding, so it's essential to consider the Dogs of the Dow's performance against the broader index. There is a website dedicated to the investment strategy that provides an array of performance statistics.

 

Here is some snapshot performance data which may intrigue you:-

 

· Between 2007 and 2009, the Dogs of the Dow underperformed the wider Dow index

· 2010 saw the Dogs of the Dow outperform, 16% against just 9% for the broader index

· In 2011, the strategy outperformed the main index by 11%

· 2012 was a draw, a 10% increase for each index

· 2013, 2014, 2015, 2016, 2018, 2019, 2021 and 2022 saw the Dogs of the Dow outperform

 

In 2020, the Dogs of the Dow strategy registered a record loss, falling by 12.6%, while the main index increased by 7.2%. As often happens, in the following year, there was a record gain of 25.3% against the comparable increase of 21% for the main index. In the final full calendar year, the strategy saw an increase of 10.1% in 2023, which was lower than the 14.4% for the wider index. Is this a reflection of a return to more traditional market conditions?

 

The pros and cons of the Dogs of the Dow investment strategy

 

It's important to choose an investment strategy which aligns with your long-term aims and attitude to risk. As with any investment strategy, there are pros and cons which you need to consider:-

 

Pros

 

· Simple

· Steady income

· Low risk (relatively)

 

Cons

 

· Rigid

· Underperformance in  bull markets

· No appreciation of sector diversification

 

The Dogs of the Dow investment strategy is based on income security, which tends to attract investors in volatile and uncertain markets. Obviously, there is a risk that the companies could reduce or even pass on their dividend in challenging times. There is an added degree of security because they are larger, more established companies, but this does not mean they are immune from financial difficulties.

 

Conclusion

 

The term “Dogs of the Dow" is not the most appealing, but when you look at the strategy itself in detail, its simplicity is refreshing. We live in a world where investment strategies are becoming more complex, often involving derivatives and other products, so sometimes it is good to get back to basics.

It was interesting to see that the strategy underperformed just before the US subprime mortgage crash, but it tended to perform better in the nearly 15-year period since, during which there have been numerous financial challenges. The strategy is not for everybody, and it's essential to take advice from your financial adviser before committing funds.

 

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