What Is Your Opinion of the Dogs of the Dow Strategy?

[Den18]

I have not seen this discussed here so I wanted to ask. For those who are not familiar, Dogs of the Dow is an investment strategy Jacob over at ERE (http://earlyretirementextreme.com/day-21-investing-for-early-retirement.html) recommended for those with little investment knowledge (*raises hand).

More here: http://www.dogsofthedow.com/

What is the opinion of the mustachian community about this strategy? From my very limited knowledge and from previous returns it seems like a solid strategy that more than keeps up with inflation while also giving you a solid return to live on.

Thoughts?

[arebelspy]

It's certainly not a bad strategy.

I prefer a total return index strategy as outlined on JLCollins' blog. 

Less work, more diversified, less risk.

A simple google search will help you find some of the cons:
http://www.stockscreening101.com/dogs-of-the-dow-issues.html
http://seekingalpha.com/article/255299-dogs-of-the-dow-investment-strategy-does-it-work-or-not

But to each his own.  If it makes sense to you and lets you sleep at night, go for it.

[Den18]

Thanks arebelspy, I will take a look at return index strategy.

I did google it and found those and other links but I do not understand how those are downsides. It feels like the authors were just trying to come up with downsides of the top of their heads. Maybe I believe this because I am not a experienced investor but when I look for downsides I expect something like the strategy does not work, does not work well enough, has too much risk or reasons of that ilk. Not "you are missing out on international investments" or "it might be becoming too popular".

It did have a significant loss in 2008 but I am not familiar with anything that did not lose value in that year.

I hope I do not sound self-righteous about the strategy as that is not what I intend, but I have yet to find any good discussion about it. So I thought I would ask here :).

[erejacob]

The most important downside is that Dow stocks which are supposed to be very solid may turn out not to be and become value traps... then later dropped from the Dow.

This is what happened in 2008 with the banks in the DJIA.

Of course if you had held the DJIA index you'd have had the same problem. Avoiding this would have required paying attention.

Otherwise the DoD is similar to simply holding the Dow index except you're skewed towards value which from the French-Fama studies is one of the three factors which outperforms the market historically... probably because the market is not psychologically efficient (one of the irrationalities of humanity is a preference for instant gratification that is growth). The other two factors are low beta stocks (human weakness = excitement, so fun stocks are overbid) and small cap (human weakness = trust in big stuff, so big companies are overbid).

Also you get a dividend. This is my primary reason for it. Total return is all fine when you have a wage-income and save. However, when you have to generate money on a regular basis from a portfolio ... well, I don't like to sell shares if I can avoid it.

If you're looking to learn more/take a active role, DoD is good. It's as mechanical as the fashionable index ETF rebalancing strategy but it's closer to the bone since the companies aren't wrapped inside a fund. Also there are no-fees which is better than low-fees.

[arebelspy]

Also you get a dividend. This is my primary reason for it. Total return is all fine when you have a wage-income and save. However, when you have to generate money on a regular basis from a portfolio ... well, I don't like to sell shares if I can avoid it.

Yeah, this is one area where I disagree with you. Dividends are fine, but they get so much hype, I feel they're really overrated right now.  There is nothing special about a dividend.  It's not magical free money that doesn't affect the return of the stock.  Taking dividends rather than reinvesting and having your shares go up some is the same as having your shares go up more and selling some.

I have no reason to believe a company that gives dividends versus that exact same company that doesn't won't generate me the same amount of money by the former going up less in value due to paying out dividends and the latter going up more in value and me selling.

People argue that with just taking dividends you won't run out, whereas selling stocks you might, but the idea would be at a SWR the stocks would rise more in value than you need to sell, and thus you wouldn't run out.  And you run into the same problem with dividends: by not reinvesting, the value grows more slowly and due to inflation your dividends may soon not cover your expenses.

Functionally the end up being the same, besides having to decide when to sell in a total returns portfolio.

Tax treatment is the only potential difference, and it's likely that capital gains > dividends soon anyways.  (YMMV if in Canada, there's a separate discussion thread on that.)

You know what you're doing Jacob. 

But there's so much dividend hype out there that investors that don't know what they're doing get sucked into the hype and overvalue dividends at the expense of a solid investment plan.  That worries me.

[MooreBonds]

Also you get a dividend. This is my primary reason for it. Total return is all fine when you have a wage-income and save. However, when you have to generate money on a regular basis from a portfolio ... well, I don't like to sell shares if I can avoid it.

+1

While I personally would follow other investing strategies before adding the DoD to my portfolio arsenal (value trap, less diversification, and 'arbitrary' index selection by Dow Jones staff), the above is my main reason for including a heavy part of my US section of my portfolio in dividend-based selections, with the majority of my expected juicy growth coming from int'l/emerging markets.

Yeah, this is one area where I disagree with you. Dividends are fine, but they get so much hype, I feel they're really overrated right now.  There is nothing special about a dividend.  It's not magical free money that doesn't affect the return of the stock. 

Taking dividends rather than reinvesting and having your shares go up some is the same as having your shares go up more and selling some.

If you are sticking to mainly mutual funds and ETFs, then you are correct. However, I have probably 60% of my investments (or even more) in individual stocks. Because of this, I'd much rather have an overall average portfolio yield of, say, 3.5% that I can take and then spend as it comes in....rather than having to go through and sell 2 shares of this, 23 shares of that, 11 shares of this each quarter, and get dinged for commissions (and these days, a NIGHTMARE of a Schedule D on your taxes). 

You could elect to sell entire positions in 3 stocks each quarter, versus the 'death from a thousand commissions'...but then you end up having to whittle a list of prospective sell candidates down, then go through a selection process to figure out which one(s) to sell, etc.

I am DRIPing the dividends currently, but once I turn off the DRIP and start spending the dividends, I'm somewhat (hopeful)confident that the average portfolio yield will approximately keep up with inflation.

[arebelspy]

If you are sticking to mainly mutual funds and ETFs, then you are correct.

And I think the vast majority of investors should stick with index funds.  So for the vast majority of investors, total return > dividends.

The rest of your post just adds one more argument (on top of the many) as to why holding individual stocks isn't optimal.

Like I said, do what works for you.  Jacob likes Dog of Dow, great.  You like dividends (but not DoD)?  Cool.

But, IMO, for most investors index fund investing and total return is the superior way to go, as it tends to offer less risk, is more diversified, and takes less work.  It may potentially offer less returns to someone who knows exactly what they're doing, but for most people it will offer greater returns as well, by avoiding common investor pitfalls and trying to time the market.

YMMV.

[erejacob]

I think the choice is confused because the "vast majority of investors" aren't really investors. Rather, they're people who save in an alternative currency called "the stock market" because they've heard that historically it has paid higher rates than a savings account. Such "investors" are better thought of as savers.

Savers should put their money in index funds, for now, for all the usual reasons. Index funds provide the highest return to personal effort ratios of all strategies, as does any popular strategy. "I'll have when she's having, thank you." (I use that strategy at restaurants because I'm not interested in finer cooking. It's just calories to me.)

Like with any hobby, those who are willing to add some value to the process can harvest some additional reward. Investing is one such hobby. Knitting or cooking are other ones. With enough effort, amateurs can certainly beat professionals in niche areas of any field.

I think that someone who wants to make a living from money should at least be somewhat informed about the process. Kinda like someone who eats hamburgers should at least be somewhat informed about how the meat ends up on the table. That's a philosophical point. I understand many don't care to know. Those folks are not the target group of my recommendations.

For those who are interested in learning about investing in individual companies, DoD is a good safe place to start. It involves discipline, portfolio management, cash flow duration considerations, taxation events/consequences, and individual companies in a mostly non-scary environment. I also think that DoD is close to a better-informed strategy intended to survive for 60 years while providing a steady income. This is the reason I suggest the DoD as a starting point. It is not because I think "savers" should specifically pick this strategy and then proceed to ignore its details.

[arebelspy]

Fair enough.

I think wat you call "savers" most people still call investors.

What I would term your "investor" (usually) as "trader."

Just a terminology thing though, not important.

[fiveoh]

If you go to sell your non-div stocks to generate income in a recession they will be worth much less and your portfolio can take a huge % hit during those years.  However if you are collecting dividends, you wont need to hit your principal nearly as bad in the low points of the market.   I.e. if you need 20k a year to live and have a 500k portfolio, if you retire in 2008 when your portfolio value drops to 380k now you are taking a much larger % of your overall portfolio for that 20k.  This can be really hard to recover from.  Another positive for dividends vs nondiv stocks for income...

[arebelspy]

What makes you think dividends won't necessarily be reduced in a recession?  And there are still strategies (such as a cash buffer) to avoid the problem you describe.

[fiveoh]

What makes you think dividends won't necessarily be reduced in a recession?  And there are still strategies (such as a cash buffer) to avoid the problem you describe.

It's very likely that some of them will be.  However there are quite a few companies that have been paying(and increasing) dividends for 25 years + thru many downturns.  See the list at :
http://dripinvesting.org/Tools/Tools.asp if you are interested. 

[arebelspy]

I don't have a whole lot of reason to believe past results will predict the future, in this case.

If anything, I'd rather choose the ones who didn't quite make it (the ones they call "Frozen Angels"), as they are less likely to be overvalued by the people parroting this strategy.  Still, I have no reason to think they will outperform the market as a whole when all returns are taken into account (dividends and capital gains).

If one really knows what they are doing, they may be able to eke out higher returns.  If they are blindly following some dividend strategy they read about, I don't believe they will (and, due to tax treatment, I believe they will come out behind).  YMMV.