Dogs of the Dow example
Let's look at how the Dogs of the Dow strategy would have worked in recent years, starting in 2018. The portfolio would have included current Dow stocks Verizon (VZ -1.31%), IBM (IBM -2.13%), Chevron (CVX -0.37%), Merck, Coca-Cola, Cisco Systems (CSCO -3.08%), and Procter & Gamble (PG +1.11%), plus former components Pfizer (PFE -0.92%), ExxonMobil (XOM -0.51%), and General Electric (GE -0.27%).
In 2018, the Dow generated 21% in total returns, while the Dogs of the Dow portfolio would have generated 27% in total returns. Four of the Dogs returned more than 45%, more than making up for the six Dogs that underperformed the index (one of which lost 8% in value).
The results in 2019 and 2020 were not favorable, with the Dogs of the Dow portfolio generating 18.7% and (7.9%) in total returns (losses) respectively, while the Dow returned 25.3% and 9.7% in those years. In 2021, Dogs of the Dow once again outperformed, with 25.3% in total returns, compared to 21% for the index.
As this illustrates, the Dogs of the Dow portfolio strategy can result in widely divergent results from year to year. Moreover, there are more consequences investors must consider before adopting this strategy, especially regarding taxes.
Since the portfolio is rebalanced and reallocated every year, there is the potential for significant tax costs weighing on realized returns. By rebalancing to the highest-yield components of the Dow, investors following this strategy will often sell some -- or even all -- of their biggest gainers from the prior year. As a result, a significant portion of any outperformance can be lost in capital gains taxes each year. Conversely, it is not uncommon for the Dogs that continue to lag to remain Dogs. So investors may not be able to offset capital gains by selling the losers and realizing those losses.
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