The strongest selling point for the Dogs of the Dow strategy: It has worked. In his excellent book How to Retire Rich, Bear Stearns Asset Management's James O'Shaughnessy explained that a $10,000 investment in the Dow Dogs in 1952 would be worth $6.6 million by 1996, compared with $1.7 million for the same investment in the S&P 500.
The Fine Print
Of course, like any other investing system, the Dogs of the Dow isn't perfect. The Dogs portfolio trailed the broader market in the heyday of the go-go late 1990s. And while the 12.2% loss for the Dogs in 2002 easily bests the 23.9% loss on the S&P 500, it also demonstrates that the portfolio can lose money. Another risk is that dividends can be trimmed or eliminated. Companies such as General Motors ( GM) and Altria face operating challenges that may force them to cut their dividends. Indeed, studies have demonstrated that companies offering slightly higher yields do better than the highest-yielding stocks over the long haul. Why? Because many of the highest-yielding stocks have huge operating problems. One of the strengths of the Dow Dogs strategy is that, presumably, companies included in the Dow Jones Industrial Average are more durable than the broader stock universe -- but that hasn't always prevented collapses. That brings us to another downside to the strategy: The stock might tank. "A 10% drop in a stock one day can wipe out a year's worth of dividends," said Michael O'Higgins, founder of O'Higgins Asset Management in Miami Beach. "Sure, that drop will get you a higher yield, but it doesn't help much when the stock is tanking." The name O'Higgins may sound familiar; his 1991 book Beating the Dow helped popularize the Dogs of the Dow strategy. However, O'Higgins doesn't recommend the strategy now because he believes the market is entirely overvalued and that the economy is headed for a depression. We'll discuss more dire contrarian strategies that O'Higgins and others espouse -- think Newmont Mining ( NEM), for starters -- in future Financial Education columns.