Contrarian investment strategies are some of the most interesting ways to build wealth in the stock market. The idea is to go against the grain — making moves the average investor wouldn’t even consider — in an attempt to capture the larger gains nobody seems to be looking for.
One of the most popular of these strategies is known as the Dogs of the Dow.
As its name suggests, the strategy is centered around making investments in stocks listed on the Dow Jones Industrial Average (DJIA), also known as the Dow 30. But how exactly is investing in blue-chip companies listed on one of the most recognized stock market indexes a contrarian strategy? And what exactly are the “dogs” the strategy refers to?
What Is the Dogs of the Dow Investment Strategy?
The strategy was designed as a way to go about beating the Dow by investing in only 10 thoughtfully chosen components of the index. In particular, those following the investing strategy focus only on the 10 highest dividend yielding stocks on the index.
The concept of investing in the blue-chip stocks on the Dow with the highest dividend yield isn’t anything new to Wall Street, as the practice has been taking place for decades. The Dogs of the Dow was first popularized in a 1991 book titled “Beating the Dow” by Michael B. O’Higgins.
Importantly, the Dogs, or highest yielding stocks on the Dow Jones Industrial Average, are chosen at the beginning of the year, on the first trading session. These stocks will be known as the Dogs of the year on Wall Street until the end of the year at the very minimum, regardless of whether circumstances change mid-year and other stocks on the index begin to offer higher yields.
The Investment Thesis Behind the Strategy
There are multiple parts to the investment thesis behind this strategy. By the nature of the index, all Dow stocks are blue-chip investments. Not only are these some of the largest companies in the United States, they tend to be some of the most stable. As a result, the strategy comes with a decent level of built-in safety.
So, where does the contrarian nature of the strategy come in?
Large, well-established companies don’t tend to alter their dividend payouts, regardless of the current business cycle. That means that when times are slow and the stock is down, the dividend yield will go up, because payouts haven’t changed while the stock price has decreased.
When it comes to Dow components, a high dividend yield suggests low stock prices, and most investors tend to veer away from companies that are going through a rough patch. However, there’s a good reason investors follow this strategy anyway, investing in the Dow Jones-listed companies that most people who pick individual stocks are least likely to consider.
These companies have low valuations, making the strategy of investing in these “Dogs” a value-oriented strategy. Keep in mind, all 30 of the stocks listed on the index represent stable companies that have proven their ability to withstand headwinds and pick themselves up after they’ve fallen.
At the same time, the Dogs are likely experiencing headwinds at the time they’re chosen, meaning they’re likely highly undervalued. Once the concerns pass, these stocks are more likely than not to make a full recovery, meaning that they offer access to significant growth potential.
How Has the Dogs of the Dow Strategy Performed Historically?
Throughout history, the Dogs have beat the overall Dow quite often. Here’s a quick comparison between the two from 2010 through 2020:
Year DJIA Overall Dogs of the Dow Winner
2010 9% Gain 16% Gain Dogs
2011 5.5% Gain 6.7% Gain Dogs
2012 10% Gain 10% Gain Tie
2013 30% Gain 35% Gain Dogs
2014 10% Gain 11% Gain Dogs
2015 0% Gain 3% Gain Dogs
2016 17% Gain 20% Gain Dogs
2017 25% Gain 19% Gain Dow
2018 6% Loss 1.5% Loss Dogs
2019 22.3% Gain 15.4% Gain Dow
2020 7.2% Gain 12.6% Loss Dow
As you can see, the Dogs have produced a much better long-term total return than the Dow Jones Industrial Average, winning far more than losing. However, on a year-by-year basis, there are some years that the Dow will outpace the Dogs.
This is especially true in years when companies already dealing with headwinds face macroeconomic issues, as was the case in 2020 as the COVID-19 pandemic set in. Economic shocks like that are more likely to further impact companies that are already facing challenges.
Current Dogs of the Dow
The chart below shows the current Dogs of the Dow, their dividend yields.
|Company Name (Ticker Symbol)||Dividend Yield|
|International Business Machines (IBM)||4.69%|
|Walgreens Boots Alliance (WBA)||3.95%|
|Cisco Systems (CSCO)||2.49%|
|Merck & Co. (MRK)||3.35%|
Pros & Cons of the Dogs of the Dow Strategy
As with any investment strategy, there are some pros and cons you should consider before diving into an investment using the Dogs of the Dow strategy. Here are the most significant.
Dogs of the Dow Pros
The strategy has become a staple among contrarian investors, so it only makes sense that it has plenty of perks.
1. Limited Drawdown Risk
While the strategy is focused on investing in what many perceive to be the weakest stocks on the Dow, all 30 stocks on the index are relatively stable plays because they represent large industry leaders. As a result, the strategy comes with less drawdown risk than strategies that focus on investing in more volatile stocks.
2. Potential to Beat the Market
Historically, there have been some years when the Dow and S&P 500 have beaten the Dogs, but there have been far more years in which the Dogs outperformed the overall market. Since investing is all about making money, a strategy with the ability to expand your earnings compared to the overall market is always compelling.
Some investment strategies are difficult to carry out, but this isn’t one of them. The stocks you’ll be invested in are all chosen for you, and rebalancing is only necessary on an annual basis, making this one of the easiest strategies to follow.
4. Strong Income
Almost all the components of the Dow pay dividends, but focusing on this strategy means your investments will be centered around those with the highest dividend yields, making it a great choice for investors looking for income.
Finally, the strategy is centered around investing in a handful of individual stocks rather than potentially expensive mutual funds. Plus your transaction costs should be minimal because you’ll only be making trades once per year.
As a result, this strategy is one of the lowest-cost ways to go about investing.
Dogs of the Dow Cons
Sure, there are plenty of reasons to be excited about following this strategy, but every strategy comes with a downside or two. Here are the most important reasons why some investors choose to avoid investing in the Dogs.
1. Losses Can Happen
In the stock market, sometimes losses are unavoidable. Even the most seasoned expert investor will lose money from time to time, as will the most stable, reliable company.
Because every stock purchased using this strategy is a blue chip company, many investors dive in expecting there to be no chance of losses, but that’s a false assumption. Stocks of some companies — even large companies — may decline for good reasons.
Investing in stocks that are already underperforming carries the risk that they continue to fall, especially if something fundamental at the company has changed. A sudden shift in the economic tides can spook investors away from these companies even more than the Dow’s strongest performers.
2. Sticking to the Strategy Might Be Tough
When the strategy is producing gains, sticking to it won’t be hard at all. However, when declines happen, it may be difficult to overcome the fear of loss and stick with the Dogs.
If you decide to move forward with the strategy, it’s important that you’re willing to stick it out through the tough times. You must prepare yourself to avoid emotional investing if the market starts to turn sour.
Steps to Setting Up a Dogs of the Dow Portfolio
As alluded to above, the Dogs of the Dow is a very simple strategy to follow. All you need to do is follow the steps below:
1. Look Up the Dogs
First, you’ll need to know exactly what stocks are included in the strategy. Keep in mind that a new list of Dogs will come out every year based on the dividend yields on the first trading day of the year. So, many investors wait until the first session of the year to start the strategy. To find the current Dogs, simply look for “Current Dogs of the Dow” in your favorite search engine.
2. Buy the Dogs
Now that you know what stocks represent the Dogs, it’s time to make your purchases through your brokerage account.
If you’re following the strategy to the letter, you’ll apply an equal 10% allocation to each stock. Some investors may adjust allocation to each stock depending on various factors, such as valuation metrics. But if you’re not an experienced investor, it’s best to stick with the equal 10% allocation.
3. Adjust Your Portfolio Annually
When following this strategy, it’s important to hold your investments for a year at a time. On the first day of the new year, you’ll sell all shares, investing in the new list of Dogs on the first trading session of the new year.
There’s an important tax consideration to think about here. Investments that are held for one year or less are taxed at a higher rate than those held for longer than one year. You could benefit substantially from waiting an extra day before adjusting your portfolio. This way, you’ll hold your investments for one year and one day, satisfying the long-term capital gains tax requirements and qualifying for a lower tax rate on all your gains for the year.
Common Questions About the Strategy
There’s no such thing as an investment strategy investors won’t have questions about. When it comes to this strategy, the most common questions investors have include:
Are 10 Stocks Enough for Diversification Purposes?
Diversification is the act of making sure you don’t invest all your money into too few stocks. Instead, by spreading your investments out across several different stocks, you’ll be protected if one or more of those stocks takes a sudden dive. The gains across the rest of your portfolio will act as a safety net.
One of the most commonly followed diversification strategies is the 5% rule, which suggests investors should never invest more than 5% of their total portfolio value into any single investment.
On the other hand, the Dogs of the Dow strategy suggests that you invest 10% of your portfolio into each of the Dogs. So, which is right?
The importance of diversification is a long-debated topic, with experts on both sides of the argument — albeit far more of them land on the “diversification is important” side.
Limiting your investments to 10 stocks is a dangerous concept, but the fact that these stocks are all stable, blue-chip players leading in their industries builds some safety into the foundation of the strategy. As a result, the general consensus is that the Dogs of the Dow strategy is a relatively safe one.
Some investors still aren’t comfortable with how light the diversification is in this strategy. If you’d like further protection, simply invest 5% of your portfolio’s value in each of the Dogs, representing 50% of your portfolio’s value. The remainder can be invested in heavily diversified mutual funds or exchange-traded funds (ETFs) to offset risk.
Is Annual Rebalancing Enough?
The annual rebalancing of the Dogs of the Dow portfolio is another matter in which the strategy goes against the grain. Some investors rebalance their portfolios weekly or monthly, but almost all advisors and investment strategists advise to rebalance at least quarterly.
So, why does this strategy only call for annual rebalancing? Well, because in this strategy, it works.
This strategy is not based on diversification, instead focusing on a handful of stocks that are strong, stable investments. There is no use of bonds or other fixed-income securities that might merit regular rebalancing.
Moreover, the stocks are all Dogs, offering high yields and low prices relative to their Dow Jones-listed counterparts. The general theory is that when you invest in the downtrodden stocks that have high yields largely because of price depreciation, the undervaluations will work themselves out over time, typically within a year. If you exit your positions in a shorter amount of time, you may miss out on the recoveries these stocks are expected to make.
Are There Any Dogs of the Dow ETFs?
Some investors would rather invest in exchange-traded funds (ETFs) than individual stocks for two key reasons. First and foremost, these funds take the guesswork out of investing, with managers that invest your money for you based on the fund’s prospectus. They are also known to be one of the lowest cost ways to go about making money in the stock market.
There are quite a few ETFs that follow the Dogs of the Dow strategy or variations on the same theme. Some of the most popular are Elements ETN-Dow Jones High Yield Select 10 Total Return Index (OTC: DODXF), Invesco Dow Jones Industrial Average Dividend ETF (DJD), and ALPS Sector Dividend Dogs ETF (SDOG). Technically the ALPS funds tracks to “Dogs” of the S&P 500 instead of the Dow, but it follows the same idea.
Do I Have to Wait Until the Beginning of the Year to Start?
You don’t have to wait until the beginning of the year to start using this strategy, but if you start in the middle of the year don’t, your “Dogs” will be different from what the general public calls the Dogs of the Dow. That’s because the highest yielding stocks on the first trading day of the year will be different from the highest yielding stocks in the middle of the year when you start trading.
Regardless of when you start, you’ll want to invest in the highest yielding stocks on the Dow Jones at that time. The point is to make investments in solid stocks that are underperforming their Dow-listed counterparts in the short term. The goal is to hold the investments long enough for these stocks to recover.
A crucial piece of this strategy is that the investments are held for one year, and for good reason. If you don’t hold onto them long enough, you may miss out on strong returns. Plus, holding your investments for less than one year means having to pay short-term capital gains taxes on any profits you realize.
So, no, you don’t have to wait until the end of the year to invest in the Dogs of the Dow, but if you start in the middle of the year, make a note of the day you start and make sure to adjust your portfolio annually.
The Dogs of the Dow is an interesting strategy, centered around a contrarian opinion that stocks with strong fundamentals that are undervalued for one reason or another offer the best opportunities for reliable growth that outpaces the overall market.
The strategy is incredibly similar to that of Warren Buffett, the famous contrarian investor who amassed a fortune investing in downtrodden stocks.
While there are some downsides to taking an approach that goes against the grain on Wall Street, historically, the Dogs of the Dow has outpaced the returns of the overall market by a wide margin, making it a compelling investment strategy for many investors.