Dogs of the Dow and Other Popular Portfolio Strategies
Successful investing requires more than just picking winning stocks. It takes planning and strategy to incorporate all assets in a portfolio in order to accomplish a goal. Some investors prefer growth stocks, while others like value stocks more. But there are other kinds of strategies that don’t require a lot of thought or analysis to work.
One of the oldest methods is known as “buy and hold.” It’s exactly what it sounds like. Investors pick a handful of stocks and keep them for years – many times over a decade. The idea is that the stock market trends higher over time, so holding stocks over the long term eliminates short term fluctuations in value. The problem with this plan though, is it doesn’t take into account the very real possibility of picking poor stocks that never pan out as expected.
One strategy allows for annual changes to stay on top of things, but doesn’t require more effort than simply checking yearly gains on a list of 30 stocks.
A method to the madness
The “Dogs of the Dow” is a rather unique investment strategy. Basically all that’s involved is taking the worst performing members of the Dow Jones for the year and building a portfolio made up of just those stocks. It seems counter-intuitive to pick only losers, but the data actually shows otherwise. There’s a strong correlation between members of the Dow that under-perform one year and then outperform the following year.
Here’s why this works – stocks that are part of the Dow are usually well-established brands that pay a consistent dividend. Since they are unlikely to alter their dividend payments, that means that stocks paying a high dividend relative to its stock prices in near the bottom of the business cycle and should move higher in the coming year.
For the most part, this simple strategy seems to work. Other than outlier years like the financial crisis in 2008, the Dogs of the Dow tend to outperform the Dow Jones average. It’s also a strategy best utilized by investors with a long time horizon who can withstand down years in a portfolio.
While there’s plenty of evidence to suggest that under-performing members of the Dow will outperform the next year, past performance is never a guarantee of future performance. Picking stocks and building a portfolio without giving proper consideration to diversification and fundamental analysis is akin to gambling – not investing.
The key takeaway from this esoteric investment strategy is that investors can use this methodology to apply to their own analysis. Finding quality name, out of favor stocks whose fundamental story is still sound is exactly what value investors do so well. By sticking with well-established companies whose long-term growth story is still valid, investors can make a profit by buying their stocks when they’re out of favor.