Will the Dogs of the Dow Hunt in 2013?

Last year was tough for dividend stock investors. In fact, some of the highest yielding stocks actually declined in price last year.

Even the venerable Dogs of the Dow strategy lost the scent in 2012, lagging the market’s overall gains. The question is: Will the Dow dogs get back in the hunt this year, or roll over again in 2013?

The Dogs of the Dow strategy entails investing in the ten highest yielding stocks from the 30 blue chips in the Dow Jones Industrial Average.

It’s an easy set-it-and-forget-it strategy to follow because it involves rebalancing your portfolio annually in December, yet has produced market-beating returns historically.

Alas, dogs will be dogs. And in 2012 the Dogs of the Dow gained just 9.8 percent compared to a 16 percent advance for the broader S&P 500 Index. Even within the index, dividend paying stocks fared worse.

S&P 500 dividend paying shares were up a respectable 16.1 percent in 2012 — but non-dividend paying stocks in the index posted even stronger gains of 19.2 percent!

Dividend under-performance looks even worse if you sub-divide the S&P 500 Index into ten slices — or percentiles — by yield, as the folks at Bespoke Investment Group did in the graph below.

As you can see, the bottom one-fifth of S&P 500 dividend stocks, those paying little or NO dividends (far right bars), gained an average of 17.3 percent in 2012, while the top 10 percent (highest dividend yields at far left) actually declined -0.6% last year!

Perhaps, this underperformance can be attributed to the fiscal cliff debate in late 2012 and fears that stock dividends might once again be taxed at higher ordinary income tax rates. In the end these worst fears weren’t realized, although tax rates for both dividends and capital gains move up to 20 percent this year from 15 percent last.

With this issue now resolved, the Dogs strategy should heel to its historic out performance once again. After all, in 2011 the Dogs posted an average total return of 16.7 percent while the S&P 500 Index was flat.

And the strategy has been best-in-show over the long run, too.

The folks at Dow Jones created an index to track the Dogs of the Dow strategy back in 2000. Since inception, the Dow Jones High Yield Select 10 Total Return Index has gained 173.9 percent, outperforming the Dow Jones Industrial Average, which is up just 143.1 percent over the same period!

There are several ETFs available today that follow various dividend stock investment disciplines, including one: The ELEMENTS Dogs of the Dow Exchange-Traded Note (DOD), designed to track the Dow Jones High Yield Select 10 Index.

In a world where yield remains scarce, with 10-year Treasury bonds offering yields under 2 percent, and many retiring baby-boomers seeking more income, the Dogs strategy still has much potential for conservative investors.

It’s not all about capital gains. In today’s volatile markets, dividend income is just as important as ever … and perhaps even more so.

Remember, over the long run almost HALF of the total return from stocks comes from reinvested dividends. And today, 40 percent of S&P 500 companies offer dividend income greater than that of the 10-Year Treasury, plus capital appreciation and dividend growth potential that bonds simply can’t match.

The Dow Dogs may not always be an investor’s best friend, but it’s a clear-cut, conservative strategy worth considering for higher than average dividend income while you wait for long-term capital gains.

Good investing,

Mike Burnick

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.