Dogs of The Dow Performance Worse Than Index Fund

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I’ve gotten a few questions about the Dogs of The Dow, which is a stock-picking strategy that involves buying equal amounts of the 10 highest-yielding stocks from 30 companies in the Dow Jones Industrial Average. At the beginning of each year, you adjust the portfolio to again to hold only the top 10 highest-yielding stocks from the previous year, selling the rest.

This strategy had its 15-minutes of fame in the 1990s, but somehow keeps popping up now and again. At the site, you’ll see a rather biased presentation of this strategy. I mean, look at the very first sentence of the site, after all the ads (emphasis mine):

Looking for a simple way to select high dividend yield Dow stocks for your investment portfolio? 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 (As reported in U.S. News & World Report, July 8, 1996)

Umm… yes, in 1996 this strategy was found to have excellent results looking backwards (known as data mining). That was fifteen years ago! You’d think the stats would have been updated a bit since then. I wonder why it hasn’t? Perhaps it’s because the Dogs of the Dow strategy has since lagged the Dow itself over the last 15 years. Check out this MarketWatch article by Mark Hulbert:

The strategy took the investment world by storm in the early and mid-1990s, on the strength of both its simplicity and excellent long-term track record — at least when back-tested. A funny thing happened on the way to the bank, however: In real time since then, the strategy has failed to keep up with a simple index fund. For example, the strategy has beaten the Dow itself in just 5 of the last 15 calendar years. And those five winning years have not come close to making up for the losses incurred in the 10 losing years.

As with many such simplistic strategies, as soon as it is pointed out, the market adjusts and the outperformance disappears. So while I’m still intrigued by the idea of living off of dividend income, I see nothing special about the Dogs of the Dow.

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  1. Do you think ETF portfolio allocations (Ferri, Swensen, Swedroe, etc) will lose their outperformance over time?

  2. I have been toying for some time with the idea of following a Dogs of the Dow for a small portion of my portfolio just for the fun of it. I had not done much research into it, but it seems every-time I read something about it, it always seemed glowingly positive. I appreciate your unbiased post on the topic.

  3. @ Blitzer,

    I don’t believe the aforementioned ETF allocation portfolios were meant nearly so much for outperformance as to capture the overall market with the least amount of volatility (risk).

    In fact, most people falter because they insist on trying to outperform instead of simply accepting market returns.

  4. @Bitzer – It depends. For most portfolios it’s just capturing market returns through index funds. So there is no stock-picking risk (manager risk) like with this Dow strategy. The most simple portfolios simply combine capturing market returns and combining non-correlated assets like stocks and bonds to reduce risk and volatility in portfolios. The main source of outpeformance is lower costs, which most folks even Morningstar will admit is a pretty durable source of better returns.

    Some portfolios may have an emphasis on small stocks or value stocks. Both small stocks and value stocks have historically outperformed the general market historically over 80+ years. If you believe this is just an anomaly, then they might underpeform in the future. If you believe that is due to their higher riskiness, then maybe they will continue to be riskier and thus have higher average returns.

    This is a very broad summary, and I’ll stop rambling now. 🙂

  5. Just a note – In 2008, the Dogs of the Dow would have you owning both Citigroup and General Motors as two out of your ten stocks. I believe both lost 75%+ of their value in 2008 and cut their dividend to zero. GM was bailed out by the government, and Citi was pretty much bailed out indirectly along with the rest of the financial industry.

  6. I am pretty obsessed with the Dividend Aristocrat and Dividend Champion list! check them out:

  7. The past 15 years was an abnormal period, when a disproportionate percentage of equity returns came from price appreciation. Dividend income strategies had fallen out of favor for some time, and Andy Kessler would write WSJ op-eds mocking investors who desired yield with their stocks.

    If a strategy becoming too popular is a sign of its waning effectiveness, the same can be said that popular debunking of the strategy would be a contrarian indicator it is about to come back. Remember all those mid 2009 press articles about a “lost decade in stocks” right about when the market went on a 40-50% run?.
    Companies’ revenue growth is challenged by macro headwinds, and their profit margins are already at historical peaks. What will drive earnings growth to drive price appreciation? Buy they do have cash piles on their balance sheets. Where do you see the bulk of future equity market returns coming from? Increased dividend payments.

  8. I like the idea of buying strong blue chip stocks that are temporarily out of favor, but think there are better ways to do it.

    One interesting approach I’ve come across is more Buffett like. Morningstar created an ETN that invests in 20 stocks which have “wide moats” but for whatever reason are temporarily discounted. Interesting approach. The ticker is WMW.

  9. As Chris says, now you get articles debunking ‘Dogs of the Dow’ as an
    investment strategy, so NOW might be a good time to adopt it for SOME
    of your portfolio, at least. (Just a guess…..)

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