The "Dogs of the Dow" theory (DOTD) was popularized in the early
1990s as a way to beat the broader stock market's (NYSEARCA:VTI)
returns. Since then, the strategy has posted impressive results by
outperforming the S&P 500 (NYSEARCA:SPY).
Who are 2013's "Dogs" and how does the strategy work?
Dogs Snapshot
The DOTD strategy uses a relatively straight forward approach by
selecting and rebalancing into stocks within the Dow Jones
Industrial Average (NYSEARCA:DIA) whose dividend yield is the
highest.
The theory behind choosing DJIA stocks with a high dividend
yield is that they are closer to the bottom of their business cycle
and are likely to see their stock price increase faster relative to
lower yielding stocks.
The DOTD is an equal weighted portfolio strategy, meaning
each of the 10 highest yielding stocks are owned the same
proportion. For example, a $100,000 investment portfolio would
allocate $10,000 to each of the 10 dogs.
Variations of the DOTD Theme
There are variations of the DOTD strategy. The "Small Dogs of the
Dow," for example, are composed of the five lowest priced stocks
within the DJIA.
The ALPS Sector Dividend Dogs ETF (NYSEARCA:SDOG) is an ETF that
applies the DOTD strategy, but on highest yielding S&P 500
stocks. SDOG equal weights its 50 stock portfolio at both the
sector and stock level. Each stock gets 2% representation while
each sector is given 10% exposure. SDOG is rebalanced quarterly and
the actual holdings are reconstituted at the end of each year.
SDOG's annual distribution yield is 5% and the fund charges
annual expenses of 0.40%.
Historical Results
From 1992 to 2011, the DOTD strategy matched the annual return of
the DJIA (10.8%) and beat the S&P 500 (9.6%), according to the
Dogs of the Dow website.
The Small Dogs of the Dow posted even better results by gaining
12.6% over that same time frame.
Although both strategies have not beaten major stock benchmarks
every year, their performance over longer periods has been good.
This is true despite periods of underperformance like during the
dot-com heyday (1998-99) along with the credit crisis
(2007-09).
This Year's Names
Dec. 31 of each year is the typical annual rebalancing date for
portfolios using the DOTD strategy. For investors holding the
previous year's "Dogs," the idea is to re-target your stock
holdings back to a 10% weighting. Annual rebalancing also allows
you to own more shares in the Dow stocks that have lagged in
performance along with reducing overconcentration in the stocks
that have run up in value.
The table below lists the 10 highest yielding DJIA stocks as of
the market close on Dec.31, 2012. Rounding out the top three stocks
on the 2013 list are AT&T (
T
), Verizon (
VZ
), and Intel (NASDAQGS:INTC). We've also listed the five DJIA
stocks, (also known as the "Small Dogs of the Dow") with the lowest
2012 closing share price. Hewlett-Packard (
HPQ
) and General Electric (
GE
) are among the 2013's Small Dogs.
In summary, here's the lowdown on the DOTD
strategy:
Advantages
Fairly easy strategy to employ
Stocks held in the portfolio are established companies
Disadvantages
Not a diversified strategy and concentrates equity risk in just a
handful of holdings
Trading transaction costs associated with annual rebalancing
corrodes returns
Check out ETFguide's
Income Mix
Portfolio
, which generated $10,422 in annual income in 2012. The portfolio
is designed to generate high monthly income using covered call
options. The Jan.2013 trade garnered $654 in monthly income.
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