Dogs of the Dow: A Nifty Strategy for Potentially Increasing
Yield in Your Living Trust
Increasing yield - while maintaining an appropriate allocation -
is often a difficult trick for trustees of living trusts. But
one tool you can pull out of your kit is the "Dogs of the Dow,"
a contrarian strategy designed to potentially increase yield and
growth.
First put forth by Michael O'Higgins in his 1991 book, "Beating
the Dow", the strategy itself is the model of simplicity. You
select the 10 Dow stocks with the highest dividend yield and one
year later rebalance to the new 10 with the highest yield.
The theory is that the DJIA is made up of high quality issues,
and the highest yielding securities among those high quality
issues are those that have increased dividend yield due to their
stock prices being depressed. While waiting for the stocks to
regain favor [the potential for growth], an investor can reap
higher than normal income [increased yield].
Looking back to 2004, average yield for the DJIA was around 2%.
The "Dogs," as of the beginning of the year, had a yield of
3.61%. At the end of the year, the total returns (including
dividends) of the dogs were 4.5%. The Dow industrials had a
return over the same time period of 5.31%. (For a complete list
of the 2004 "Dogs of the Dow" email me at
Dahlkefinancial@sbcglobal.net ).
For those wondering what the worst performing stocks in the dogs
were in 2004, look no further than Merck, which turned in a 30%
drop, and General Motors, which fell by 25%. Risk is inherent in
all investing and this is no exception.
Studies are inconclusive when comparing the total returns of the
entire Dow with the total returns of the Dogs over long periods
of time. Both seem to have streaks of over or under performance
without any discernable reason. Since this is an ongoing debate
between proponents and critics, a quick browse of the internet
will give you all the needed reading material you might want on
the subject.
Regardless of the debate, I don't think this alters the use of
the "Dogs of the Dow" in a trust that is looking for increased
yield while still seeking capital growth. The easy alternative
for income is to increase your bond allocation, but that doesn't
address the capital growth aspect found in stock.
Yes, there is a tradeoff in the yield of bonds, but a trustee
trying to balance the needs of the income and principal
beneficiaries should know all about those kinds of tradeoffs.
A couple of remaining points:
Although it is common for this strategy to begin and end on a
calendar year, it is not necessary to do so. Returns, of course,
will differ depending on the dates used. MSN Money is a good
internet source for the current list. Type "Power Searches" in
the MSN search box and go to "Dogs of the Dow."
You should also know that various offshoots of the Dogs of the
Dow have emerged as of late.
These include what the Motley Fool has called the "Foolish Four
Strategy," as well as other variations that either contract or
expand the base 10 stocks in the dogs.
Of course, it is important to remember that investment returns
and principal value will fluctuate, so it is always possible to
lose money. No strategy can assure success or prevent loss.
If you have any questions or comments, Chip would love to hear
from you. You may contact him by email at
dahlkefinancial@sbcglobal.net. You may also contact him by going
to the Living Trust Network's web site. Its URL is
http://www.livingtrustnetwork.com.