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Would A "Dogs Of The DOW" Retirement Portfolio Survived The Last 12 Years?

The Question

Back in the late nineties I read a number of financial articles and books as a prelude to picking companies for my IRA. It was then I stumbled across something called the "Dogs of the Dow" or DoD.

I even tried the DoD method for a while before moving on to other things. But in retrospect I've wondered, how good a method was DoD; how well would it have survived, to twist a Southern phrase, "The Recent Unpleasantness;" and if I had retired in 2000 with a portfolio managed according to the DoD method, would the portfolio have survived that aforementioned "Recent Unpleasantness"?

For those unfamiliar with the DoD, I've summarized the method as:

On the last day of the year, sort the thirty stocks that comprise the Dow Jones Industrial Average (the DOW) by dividend yield and buy on the first trading day in the new year, an equally weighted portfolio of the ten stocks with the highest yield. Sell the entire portfolio on the last trading day of the new year. Wash, rinse, repeat.

I've purloined my DoD historical data from the informative website, http://www.dogsofthedow.com.

A First Look

I split the analysis into two scenarios. Both start with $10,000 cash in an IRA on 1 January 2000. And both end on 31 December 2011.

  • Scenario A: the portfolio is liquidated at the end of the year and the entire cash balance is invested at the beginning of the following year.
  • Scenario B: the portfolio is liquidated at the end of the year, cash is pulled from the proceeds and the remainder is invested at the beginning of the following year.

With Scenario B we withdraw $400 from the portfolio at the end of the first year before investing the balance on the first trading day of the new year. In the following years, we increase the withdrawals each year by 4%.

For simplicity I've made a few simplifying assumptions:

  • The portfolio is equally balanced when bought. For example, in the first year $1000 of each stock is bought, which means on 3 January I would have bought 42.6621 shares of (what was then) Philip Morris.
  • Transaction costs are zero. In other words, I've found the ultimate low cost broker, one that does not charge a commission.
  • Annual performance is not taxed. I assumed the portfolio is held in either in a tax deferred account (i.e., IRA) with taxes paid on withdrawal, or in a tax-exempt account (i.e., ROTH IRA) with no tax imposed on withdrawal. Of course, this also assumes all the other legal requirements are met for penalty free withdrawals.

A Results

For scenario A, the computation seems simple and straightforward, multiply the invested amount by the DoD average annual performance. For example, the 2000 DoD performance is:

Symbol

YTD % Change

(NYSE:MO)

91.3%

(NYSE:JPM)

30.7%

(NYSE:CAT)

0.5%

(NYSE:GM)

-29.9%

(EK)

-40.6%

(NYSE:MMM)

23.1%

(NYSE:XOM)

7.9%

(NYSE:DD)

-26.7%

(SBC)

-2.1%

(NYSE:IP)

-27.7%

Table 1. Year 2000 DoD performance summarized from http://www.dogsofthedow.com/dogs2000p.htm.

Which gives an average rate of 2.65% for the year. Thus an investment of $10,000 would increase to $10,265.00

However, the DoD website contains the following caution... Note 1: 2000 % change figures do not include for dividends, commissions, or taxes. Similar notes exist for the other historical DoD results.

We've already assumed no commissions or taxes. But will ignoring dividends be a result altering mistake?

Table 2. Year 2000 DoD dividend performance.

(Notes: Historical data from Yahoo! Finance. EK historical data available as EKDKQ. GM historical data was available until the end of June 2012 as LTMQQ. SBC is currently listed as T because SBC later bought the original AT&T and adopted its name and symbol.)

$10,000 invested in the Dogs of the DOW on 3 January 2000 results in dividends of $255.08 or a 2.55% dividend return... nearly the same amount as the increase due to stock price increase.

If we adjust the posted results for dividends, the average annual performance significantly changes... for the better.

Year

Raw DoD

Dividends

DoD + Div

2000

2.65%

2.55%

5.20%

2001

-7.79%

2.48%

-5.31%

2002

-12.24%

3.47%

-8.77%

2003

23.57%

4.09%

27.66%

2004

0.48%

5.49%

5.97%

2005

-8.91%

6.21%

-2.70%

2006

24.82%

7.44%

32.26%

2007

-1.44%

6.53%

5.09%

2008

-41.62%

9.03%

-32.59%

2009

12.91%

4.01%

16.92%

2010

15.49%

3.40%

18.89%

2011

12.22%

2.78%

15.00%

Table 3. Annual average DoD performance raw and corrected with dividend returns.

Chart 1. Annual average DoD performance raw and corrected with dividend returns.

At the end of twelve years we have the following results assuming we make a one time initial investment of $10,000.

Year

Raw DoD

Direction

DoD+Div

Direction

2000

$10,265.00

$10,520.08

2001

$9,465.36

$9,955.32

2002

$8,306.80

$9,073.84

2003

$10,264.71

$11,569.64

2004

$10,313.98

$12,240.71

2005

$9,395.00

$11,871.47

2006

$11,726.84

$15,647.37

2007

$11,557.98

$16,389.48

2008

$6,747.55

$10,960.86

2009

$7,618.66

$12,760.00

2010

$8,798.79

$15,156.80

2011

$9,874.00

$17,418.85

Table 4. Result of $10,000 invested at the beginning of 2000.

In twelve years from January 2000 to December 2011 the "raw" DoD portfolio experienced 7 up years and 5 down years with a net loss of $126 and a CAGR of -0.11%. If we account for dividends, the portfolio experienced 8 up years and 4 down years with a gain of $7,418.85 for a CAGR of 4.73%.

To quote Paul Harvey, "we now know the rest of the story"... dividends significantly improve the results published on the Dogs of the DOW website.

B Results

For scenario B, we need to compute the annual withdrawals. We start with 4% of the initial investment and increase the withdrawal by 4% each year. Why?

While 4% is arbitrary, it is a commonly used withdrawal rate. Why increase the withdrawal rate by 4%? Inflation.

For example I used the cumulative inflation calculator at inflationdata.com (inflationdata.com/Inflation/Inflation_Ca...) and the CAGR calculator at investopedia (http://www.investopedia.com/calculator/CAGR.aspx) to discover the following:

Start

End

years

Cum Infla

$100.00

CAGR

Jan.1991

Dec.2000

10

29.27%

$129.27

2.60%

Jan.1981

Dec.2000

20

100.00%

$200.00

3.53%

Jan.1971

Dec.2000

30

337.19%

$437.19

5.04%

Jan.1961

Dec.2000

40

483.89%

$583.89

6.06%

Jan.1951

Dec.2000

50

585.04%

$685.04

4.93%

Table 5. Historical inflation table. $100 in 1991 would have to grow to $129.27 by 2000 to have the same purchasing power.

Based on recent history, increasing the withdrawal rate by 4% per year to account for inflation seems reasonable.

Year

Withdrawals

2000

$400.00

2001

$416.00

2002

$432.64

2003

$449.95

2004

$467.94

2005

$486.65

2006

$506.13

2007

$526.37

2008

$547.43

2009

$569.32

2010

$592.10

2011

$615.78

TOTAL

$6,010.32

Table 6. Withdrawing 4% of initial investment at the end of the first year, increased by 4% each year.

When we make the annual withdraws the computations become a bit more complex, but the results are decidedly different.

Year

Raw DoD

Direction

DoD+Div

Direction

2000

$9,865.00

$10,120.08

2001

$8,680.52

$9,170.48

2002

$7,185.38

$7,952.43

2003

$8,429.03

$9,733.97

2004

$8,001.55

$9,928.28

2005

$6,801.95

$9,278.41

2006

$7,984.06

$11,904.59

2007

$7,342.72

$12,174.22

2008

$3,739.25

$7,952.57

2009

$3,652.66

$8,794.01

2010

$3,626.46

$9,984.38

2011

$3,453.72

$10,998.58

Table 7. DoD with annual withdrawals.

Chart 2. DoD performance raw and corrected. Withdrawing 4% of initial investment at the end of the first year, increased by 4% each year

In the twelve years from January 2000 to December 2011 the "raw" DoD portfolio with annual withdrawals experienced two up years and ten down years with a net loss of $6,546.28... if we don't include the twelve withdrawals which total $6,010.32. If we do include the withdrawals we are still down $535.96.

If we include dividends in the DoD portfolio and make the annual withdrawals, the portfolio experienced 8 up years and 4 down years and gained $998.58... if we don't include the twelve withdrawals of $6,010.32. If we do include the withdrawals we are up $7,008.90.

I know of no one in the U.S. who would have retired in 2000 on $10,000, but the numbers are easily scaled. For example, multiply the numbers by 100 and an initial portfolio of $1,000,000 grows over twelve years to a value of $1,099,858. The initial cash 4% withdrawal at the end of 2000 grows from $40,000 to $61,578 at the end of 2011. The total amount withdrawn sums to $601,032.

The Answer

The results published on the Dogs of the DOW website don't include dividends. However, as shown above, Doggy dividends are absolutely critical.

If dividends are (unrealistically) ignored, this historical DoD portfolio fails with a CAGR of -0.11%. Annual 4% cash withdrawals (increased by 4% each year) crash the portfolio and generate a CAGR of -8.48%.

But actual DoD performance which includes dividends, paints a better and more realistic picture. For the period from 2000 to 2011 dividends exceeded required annual withdrawals for five years and contributed a significant fraction of the withdrawals in the remaining years.

A DoD portfolio created at the beginning of 2000 would have survived and grown nearly 75% for a CAGR of 4.73%.

Furthermore, even with the "Recent Unpleasantness" this DoD portfolio with annual withdrawals grew nearly $1000... even though we extracted 4% of the initial investment at the end of 2000 and thereafter grew the annual withdrawals by 4% each year. Over the 12 years we withdrew more than $,6000 even so, the portfolio grew with a CAGR of 0.80%.

So, yes a DoD portfolio established at the beginning of 2000 would have survived and grown... even if I had extracted 4% of the initial investment at the end of 2000 and thereafter grew my annual withdrawals by 4% each year.

But that raises another question, is there a better method? I'll examine that question in a future article.