November 24, 2008, 6:00 am

Dogs of the Dow; The End of A Great Investment Strategy?

by: The Financial Blogger    Category: Investment, Market and Risk,Trading
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Then I was in high school, I was working in a dollar store over the weekends. Day after day, I was watching kids buying different toys; during summer time, little boys were buying small guns and pool stuff. During winter time, everybody was looking after crazy carpets and parents were buying scarf (2 for 1,50$) since their kids were losing them on a weekly basis. Then came the Pokemons. At first, kids were coming every Tuesday (that was the day we used to receive our stock) and got in line to buy the new one.



Those small things were selling like crazy and they were so expensive, it was ridiculous (so the parents thought anyway!). After a while, we start selling them with a special price (2 for 1) and then, they were selling for almost nothing. Why was that? Everybody were selling them, kids had a handful of them and parents were getting pretty much pissed to spend $25 per week in pokemons 😉 When there is too many people engaged in something, it is often the beginning of the end…

This is what might happen with the Dogs of the Dow strategy. This passive investment strategy is based on buying the top 10 highest paying dividend stock of the Dow Jones. Every year, you do the same exercise and you sell those who didn’t make the cut to buy the new good dividend stocks.

The principle behind the Dogs of the Dow is to buy undervalued stocks (this is why they are paying such a high dividend yield) every year. On one side you are supposed to buy cheap stocks, on the other side, these same stocks are giving a really good dividend rate.

From 1975 to the year 2000, this strategy shows an investment return of 17.7% versus 15% for the Dow Jones index. This means that $10,000 invested following the dog of the Dow investment strategy in 1975 now worth 588K versus 329K if you have invested in the Dow Jones index. Quite a difference for a stupid rule, isn’t?

However, the problem is that the rule is so simple to follow that anybody can do it. Therefore, people started investing following the dogs of the Dow strategy and massive cash flow were invested. Do you know what happen to an investment trick when everybody follows it? The trick gets so popular that it doesn’t work anymore as everybody is buying and selling the same stock at the same time. This means that you have to pay a higher price when you buy and get less money back from your sell.

For example, at the beginning of 2008, while the Dow Jones was dropping by 15%, the Dogs of the Dow dropped by 25%. Does the strategy will keep working in the future? Let just say that what was obvious 10 years ago is not so simple today!

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Comments

[…] market news by unknown « Indian Stock Daily Reports (Tirumala Sec.,) Forex and Dow Jones recommended levels […]

You can’t judge any strategy by one year.

So what if it underperformed the Dow this year? It probably underperformed during some of the years between 1975 – 2000, even though it won out over time.

Simple things like the “Dogs of the Dow” work because, even if they are simple to understand, human nature makes it very difficult to follow – because of the volatility.

What happens with the “Dogs of the Dow” is that someone writes a new article about it, it gets extra popular, money gets invested, then it underperforms a couple of years, a lot of the new investors bail out, and then it starts working again.

by: The Financial Blogger | November 24th, 2008 (6:55 pm)

Praveen,
You bring an interesting point. We should actually follow the strategy for a few years in a row.

However, when I look at hedge funds that should outperform during high volatility, they have been less profitable since there are more players on the same trend.

Thanks for the good read. I think that any investing strategy this simple must have a catch; wouldn’t everyone simply be putting money away via this technique and beating the market?
I really like the article and plan to do some more research on the topic. Thanks again

by: The Financial Blogger | November 25th, 2008 (6:54 am)

Justin,

on the other side, there is a really simple way to make money with stocks: buy ETF or index funds on a monthly basis for 15-20 years. Do you know several people that do it?

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