Many investors decry the lack of simplicity in the world of investing.
After all, when we’re putting our hard-earned money at risk, it’s normal to be afraid of losing it. And whenever an investment strategy or system seems too easy, we get nervous, afraid that it’s too good to be true.
Admit it. You’re guilty as charged.
The end result? Whether we favor technical or fundamental analysis, selecting an investment becomes a convoluted ritual – just to make ourselves feel better about taking the risk.
So is investing really just too complicated?
Or do you just refuse to accept that simple investment strategies actually work?
Well, here’s one strategy that will make you believe otherwise. After you see just how easy it is, you’ll want to implement it in your portfolio immediately…
Investing Made Simple
In 1991, money manager Michael O’Higgins described an investment strategy in his book, Beating the Dow, which is now famously known as the Dogs of the Dow.
The basic tenets of his theory couldn’t be more straightforward: Buy an equal amount in each of the Dow’s 10 highest-yielding stocks on January 1. Wait 366 days. Then replace that basket of stocks with the new set of highest yielders.
And presto! You’ll outperform the Dow Jones Industrial Average over time. Ditto for the S&P 500.
Can such a simple system really work, though? You betcha!
When back-tested, the Dogs outperformed the Dow in every decade, except for the 1930s and 1990s.
Of course, it was no surprise the system failed in the ‘30s, since virtually every investment strategy failed due to the stock market collapse of 1929 and the ensuing Great Depression.
As for the 1990s, Dow stocks fell out of favor due to the tech boom that swept up investors and created the profession of day trading. (But we all know how that ended.)
Putting those two periods aside, the Dogs of the Dow system has consistently provided higher returns, on average, than the Dow and S&P 500.
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Want proof? Look no further than the five-year, 10-year and 15-year average annual returns for each.
Obviously, no system is perfect. The Dogs of the Dow is no exception.
In 2012, it only returned 5.7% – compared to 7.3% and 13.4% for the Dow and S&P 500, respectively.
However, it’s worth noting that such underperformance is the exception, not the norm. The Dogs of the Dow seldom underperform in consecutive years.
In fact, last year serves as a shining example of the system’s resiliency.
After lagging in 2012, the Dogs of the Dow delivered a total return of 34.9% in 2013. That compares to 26.5% for the Dow and 29.6% for the S&P 500.
What Does This Say About the Future?
We all know that past performance is no guarantee of future performance.
With that disclaimer out of the way, it’s time to share my prediction that the Dogs of the Dow will, indeed, outperform again in 2014.
The reason is simple…
The stocks currently yield even more – and they’re cheaper!
At current prices, the Dogs of the Dow yield an average of 3.7%. That compares to a yield of 2.1% for the entire Dow and 1.9% for the S&P 500.
In terms of valuation, the Dogs of the Dow trade at about a 15% discount to the Dow and S&P 500, with a forward price-to-earnings (P/E) ratio of 13.3.
More dividends and more potential for capital appreciation? As an income investor, it doesn’t get much better than that.
Bottom line: The Dogs of the Dow system may not be perfect. But it can certainly simplify your stock selection process. Give it a try, and I’ll check back with you in 366 days…