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. sbcglobal
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.