Taking a closer look at one popular long term investing approach.
In the mid to late 90s I remember seeing an investment strategy that stood out from the rest. The Dogs of the Dow strategy offered a pretty straightforward and easy-to-understand approach, had a solid historical performance, and seemed to be one that would outperform the market consistently going forward. Isn’t that what all investors want? Doesn’t it sound like the golden nugget that all investors scour online broker forums and financial magazines for? Fast forward to today and investors are still drawn to this strategy for the same reasons I had back then. And, there is already much talk about 2010’s Dogs of the Dow and how it will do.
Dogs of the Dow: Top Investing Strategy or Brilliant Marketing?
I guess you may think that I’m the perpetual cynic, but I hate to tell you that the Dogs of the Dow really do not perform the way many would lead you to believe. Looking around the internet, many of the titles and jargon certainly would have you thinking otherwise:
“Try Dogs of the Dow. Read on and you will discover a technique that would have given you a 17.7% average annual return since 1973! That’s not bad, especially considering that the Dow Jones Industrial Average overall return was 11.9% during that same period.”
“During the tech bubble of the late 90s, the high dividend stocks of the Dogs of the Dow were up 28.6% in 1996, up 22.2% in 1997, up 10.7% in 1998, and up 4.0% in 1999.”
”During the difficult bear market years of 2000-2002, the Dogs of the Dow were up 6.4% in 2000, down 4.9% in 2001, and down 8.9% in 2002, and that was enough to significantly outperform the Dow, S&P 500, and Nasdaq.”
”In 2003, the high dividend stocks of the Dogs of the Dow gained 28.7% and made new, all-time highs despite the massive bear market of 2000-2002!”
“In 2006, the Dogs of the Dow surged to new record highs with a gain of 30.3%. The Small Dogs of the Dow did even better with a gain of 42%!”
As an investor, especially in uncertain times, it sure sounds appealing to me. And, even popular financial media outlets today consider it a strategy that outperforms the market — even if the strategy has underperformed lately.
Chart legend applies from left to right (Dogs of the Dow, S&P 500, Fidelity Magellan, Small Dogs of the Dow, Dow Jones Industrial Average, Vanguard Index 500). Image from dogsofthedow.com.
Headlines such as those above and the excitement by industry professionals have created an almost cult following. The Dogs of the Dow still seems to be a popular strategy even when it has been underperforming in recent years. And honestly, I think we all have been misled.
A Deeper Look At The Dogs of the Dow
If you haven’t heard of this before, the strategy entails buying and holding the 10 highest yielding stocks of the Dow 30 Industrials. And it’s been said that this strategy alone will help you outperform the market itself. One of the underlying premises is that these stocks have a higher yield because as “Dogs”, their prices have gone down. So, in essence, when you buy the highest yielding stocks that provide a good income yield, you’re participating in a value play — by buying stocks for cheaper prices than they are actually worth on paper.
Here is the list of the Dogs of the Dow stocks for 2010:
Dogs of the Dow List – 2010
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Dow Jones Industrial Performance (1900-2010)
Image from dogsofthedow.com.
Now I am a huge proponent of value investing, but not necessarily packaged as a strategy. I must admit that fundamentally and conceptually, this approach seems like a sound one. However, once you peel back the layers and analyze the data, there are several technical problems with the approach and the reporting from all the talking heads who eagerly advocate it. Mark Hirschey from the University of Kansas School of Business aptly explains:
“The perceived outperformance by Dow Dogs can be explained in terms of investment period selection problems, and data problems tied to the accurate measurement of portfolio returns. While there have been notable periods of outstanding relative performance for Dow Dogs, like 1973-74, there have also been periods of notable underperformance, like 1990. Rates of return on the Dow Dog portfolio also tend to be systematically overstated in the popular financial press.”
He continues to confirm my contention that promotional techniques and popular media once again perpetuate this cult following with imperfect data and not taking things like taxes and investment costs into account:
“Popular financial promotions of the Dow Dog strategy fail to correctly anticipate the magnitude of transaction costs and taxes, and their harmful effects on strategy returns. After transaction costs and taxes, one cannot outperform a simple buy-and-hold strategy by focusing on high-yield stocks included within the DJIA over the 1961-1998 period. Contrary to suggestions made in best-selling books, promotional literature from the brokerage community, and in cyberspace, one cannot outperform a simple buy-and-hold strategy with a Dow Dog portfolio of high-yield stocks from the DJIA. Any perception of a Dow Dog anomaly disappears when returns are properly calculated and both transaction costs and taxes are considered over a significant 1961-1998 investment horizon.”
You can read his abstract here.
But, despite the research to the contrary and the obvious flaws in this strategy, people still flock to this investing strategy every year. It doesn’t help that so-called experts and the popular media are still espousing the myth that this strategy consistently outperforms the market over the long term.
I’m sticking to my usual point: most so called outperformance strategies do not work consistently over the long-term and are simply promoted and marketed very well. Sure, they may work here and there but then you are left chasing returns from one strategy to the next each year, hoping that what you pick does work. It’s kind of like the guy weaving through traffic from lane to lane only to end up at the stop light at the same time as everyone else. Personally, I think you can do better on your own by implementing a general buy and hold DJIA strategy or, even better, by implementing a tactical asset allocation model. Decide for yourself and do your own research, but I think you will find that the performance numbers have been skewed to favor the ones promoting it. And, they have taken a lot of unknowing people along for the ride.
Contributing Writer: Todd Smith, CFP
Copyright © 2010 The Digerati Life. All Rights Reserved.
{ 11 comments… read them below or add one }
Let’s ***assume*** here that Dogs of the Dow is a valid investment strategy. The key problem is that it involves too much interaction, which will throw off the average Joe (me, being one of these average Joes).
Even if it guarantees the rates displayed above, I have to actively manage my portfolio, rather than the usual index “set it or forget it” method. I’d rather have the simplicity, I think.
Personally, I think you can do better on your own by implementing a general buy and hold DJIA strategy or, even better, by implementing a tactical asset allocation model.
This is a nicely balanced article, SVB. You do a good job of being fair to both sides. That’s something that is too infrequently done in investing articles, in my experience.
There are two bits of strong logic at work in the Dogs of the Dow strategy. One, you are getting solid companies (because they are good enough to be in the Dow). And, two, they are priced better than most other Dow companies (because they are currently “dogs”). So this strategy does have something going for it.
I don’t think it is fair to evaluate any strategy according to how it performs in time-periods of less than 10 years. It takes that long for the economic realities to influence prices (prices are set almost entirely by investor emotion in the short term). So it doesn’t bother me even a tiny bit that this strategy does not generate good results in every five-year time-period. The best strategy in the world will have bad stretches. If you rule out anything that has bad stretches, you are ruling out every strategy that involves purchasing stocks.
The problem that I see with the Dogs strategy is that it does not take valuations into consideration in a direct way. It does so in an indirect way; the idea of going with the “dogs” is to get good companies selling at prices low relative to those that apply for other good companies. The trouble is, there are times when just about all stocks are wildly overpriced. The Dogs strategy is not going to do well at such times and the poor performance achieved at those times is going to confuse your efforts to assess whether the strategy works or not.
I see why people like the strategy. It is rooted in an insight of great power — the price you pay for stocks must affect the long-term value proposition you obtain from them. The trouble is that many people are unwilling to get out of stocks entirely at times of insanely high prices. That always (at least so far) pays off big in the long term. Because of their emotional reluctance to take the step that would really pay off, people concoct somewhat convoluted strategies for doing what makes sense (taking price into consideration) that sorta kinda work but that also sorta kinda do not.
I almost endorse strongly the second part of your statement quoted above. I have one objection to it. It is not tactical asset allocation changes that work, but only strategic asset allocation changes. That is, it makes sense to change your asset allocation in response to big price changes, but for these changes to pay off you need to be willing to stick with them for at least five years and in many cases for 10 years. I think of a change that is going to apply for 10 years as a strategicchange. I do not believe it is possible to make effective assessments of where prices are headed over the next year or two or three.
Anyway, I certainly found this a thought-provoking piece. It gets at some important issues.
Rob
those ”out-performance” tactics are for those that think that the stock market is a place to get rich quick and are duped to believe that you can buy a block of stock hold them for a few months and sell them for a ginormous profit. The rest of us who know better do not fall for this gimmicks are are more realistic in our investing ventures and thus are a little more thorough with our due diligence.
I don’t put a lot of stock in dogs of the dow. I’d rather buy a broad based value index or fund.
A more efficient strategy would be to invest in a good mix of international, small cap and index funds. Covers all the bases and outperforms the market as well.
I liked your article about Dogs of the Dow strategy. However I know that your chart for total returns between 1900 and 2010 is actually the chart for Dow Industrials price returns over the past 110 years. It’s not the performance of Dogs of the Dow strategy.
Dow Jones average didn’t even consist of 30 stocks until 1928. So please consider changing your title of the chart from “Dogs of the Dow Performance (1900-2010)” to “Dow Jones Industrials Performance (1900-2010)”.
Best Regards,
Dividend Growth Investor
@Dividend Growth Investor,
Thanks for pointing this out! You are so right about the dates…and it looks like I got my titles mixed up. I appreciate letting me know about the slip up. I’m glad someone scrutinized this post the way you did. I trust the eagle eye of readers to keep me honest. 🙂
@Everyone else,
Thanks for your thoughts. I once was tempted to use this strategy as a value investing experiment but due to immense inertia, was just unable to put together my own Dow Dogs portfolio. From comments and analysis I’ve read about the Dogs myth, it seems that my inertia has helped. Instead, I went ahead with a general asset allocation approach — the one you associate to your age and risk profile. Am intrigued by the market timing approach that Rob combines with an asset allocation strategy. It reminds me of what Bob Brinker does, in a way (I’ve been an on and off fan of this guy).
Am intrigued by the market timing approach that Rob combines with an asset allocation strategy. It reminds me of what Bob Brinker does, in a way (I’ve been an on and off fan of this guy).
Thank you very much for your openness to and interest in the Valuation-Informed Indexing approach, SVB. I do not follow Bob Brinker’s work. So I cannot speak with confidence here. But I have heard other people talk about him. So I am at least reasonably confident that there is at least one big difference between what Brinker recommends and what I advocate.
I believe that what Brinker does is to make market timing calls. The phrase that you used above — tactical asset allocation — would indeed apply to what Brinker advocates. He looks at certain factors and determines that he believes stocks will be going down in the near future and so he lowers his stock allocation.
I don’t do that and I don’t recommend that others do that. I do not believe that it is possible to do that successfully. There certainly are going to be times when you get those calls right. There are also going to be times when you get those calls wrong. My take is that the amount you lose from getting the calls wrong is in the long run likely going to cost you more than what you gain from sometimes getting them right.
I never make a timing call. I never say “this is what I think is going to happen.” What I follow is a much more simple approach. I just look at value propositions. Stocks offer a better long-term value proposition when they are priced low than they do when they are priced high. So I go with a lower allocation when stocks are priced high than I do when they are priced low. The big difference with what I advocate is that it is not possible that there would ever be a time when it would not work in the long run. This is a huge difference.
Just to be clear, there are rare occasions when a Buy-and-Hold approach provides better returns. That happens in about one in ten of the possible returns sequences. Still, if you are following a strategy that produces better returns in only about 10 percent of the returns sequences, you are obviously taking on far more risk. So on a risk-adjusted basis, Valuation-Informed Indexing is always better.
The big thing here is that you don’t have to worry about whether the strategy is going to work or not. It always works. It is not even possible that it could ever fail. That’s true of course only in the long run. In the short run, this strategy can and often does fall far behind Buy-and-Hold. In the long run (10 years or more) this has never happened and never can happen.
This timing strategy is the only timing strategy that I know of that can never not work. This is its distinguishing characteristic. The reason why it is so “controversial” is that many view this claim as being too good to be true. I understand why people think that but I know from studying this in depth that this really works. The key to understanding why is to imagine what would happen if you ignored price when buying anything other than stocks. If you ignored price for years when buying groceries and then one day started paying attention to price, would that not be sure to help? It’s the same with buying stocks. Looking at the price of stocks when setting your allocation can never be a bad thing to do.
I apologize for putting up a long post on a thread that is only tangentially related. But I think this is important and I really want to be able to get the word out to more people. So I try to take advantage of every opportunity that presents itself to let people know of a way to invest that carries far less risk while providing dramatically higher returns. I very much look forward to the day when we can get more smart and good people looking at this and talking about this and spreading the word re this. Middle-class investors need to hear some good news for a change!
Rob
I didn’t hear about the Dogs of the Dow strategy until I stumbled across this particular post. I just looked it up. That’s a rather.. Interesting strategy to say the least. I had something in mind to that.. But given my conservative approach to investing.. I may very well develop a variation of it! Though that variation would be based on self.. Since it’s apparently irrespective to different takes on it. So it’s best to know thyself in investing.
This strategy is pretty complex if you ask me. So it’s too soon for me to say whether it’s a good or bad long term strategy. As Rob Bennett explained, this strategy doesn’t revolve around market timing, but rather as you put it, participating in value acquisition. Given the short term of the Dogs of the Dow chart you provided, coupled off with the fact that 2003-2009 era was a rather stale era for stocks in general, it’s hard for me to cast a more objective thought on this strategy.
Huh. Ought to remind myself to look more into this..
I liked your post and was curious but I am really into short term investments — a max of 5 years.
For uninformed investors like myself, when VZ deposits my monthly earnings in my IRA account i am very happy !!