In praise of simplicity

Why make life complicated when it can be so simple? Take exchange traded funds as an example. Are there other investment strategies this simple and diversified that can enable investors to do better than three-quarters of fund managers? Dogs of the Dow Jones fans say yes. They will tell you investors need only put their money in the 10 Dow Jones stocks (of the 30 in the index) offering the highest dividend yield (in other words, the highest annual dividend divided by share price). Twelve months later, you merely repeat the process, investing again in the 10 stocks providing the best yields in dividend terms.

As an investor, you should not be overly worried by the fact that this may involve shares whose price has gone down in the last year. Stocks that are unpopular with investors at least offer the advantage of being available at bargain prices. In this regard, a dividend yield above 3% can act as a brake on sharper declines in share prices.

A study published in 2003 in the Financial Analysts Journal confirms that the “Dogs” strategy has given excellent results over the last few years when applied to the Canadian market. According to the two authors who performed the research, the 10 stocks from the old TSE 35 index (we now have the TSX 60 instead) that offered the best dividend yields year after year also obtained overall yields higher than those of the reference indices, in this instance the TSE 35 and TSE 300.

Although this investment strategy may have involved a greater number of trades than a strategy consisting of investment in an exchange traded fund, yields still came out higher than those provided by the latter approach. Better still, although it may be more costly in tax terms than a strategy that consists simply of investing in an index, the Dogs of the TSE 35 method provides higher net yields.

Since dividend income is more highly taxed than capital gains, the researchers wondered if the Dogs of the TSE 35 strategy could provide an after-tax advantage. Even supposing a 40% tax rate for the Dogs of the TSE 35 and a 20% rate for an investment in a TSE 35 index fund, the Dogs option does better than index funds. With similar risk, the 10 Dogs of the TSE 35 was also more profitable than investing in all 35 companies in the TSE 35. Figures from England, Australia and continental Europe (the Stoxx50 index) show very impressive yields for foreign Dogs. In a strange paradox, it seems the Dogs strategy has worked even better in the last 10 years on foreign markets than in the United States, the country where this investment strategy originated.

Canada's Dogs of the TSX 60 is updated regularly and is available at stingyinvestor.com, in the Stocks section. The Dogs of the Dow Jones are covered at dogsofthedow.com.