written by reader Dogs Are A Man’s Best Friend: Part 1 of The Dogs of the Dow

THE BLIND SQUIRREL DIARIES

By theblindsquirrel, April 30, 2014

Greetings once again to all you GummieBulls and GummieBears! The Blind Squirrel here, coming to you this month with some musings on an investment topic I’m sure most of you have heard about in the past. Some may have used it as a basis for building an investment portfolio. And some of you have perhaps given it a quick look and discarded it as just being far too simplistic for your tastes. I’m talking about what is commonly referred to as “The Dogs of the Dow” theory of portfolio management.

I know this concept has been around since at least the late 1980’s and been beat to death time and time again by other writers, investors, and websites. Some like it. Some do not. Some find it an easy and productive way to run a portfolio without having to become an investment analyst and spend countless hours doing due diligence, research, and keeping abreast of day-to-day changes in the market or the individual issues involved. Some think of it as a cop-out in being a responsible investor due to the fact that it takes little thought to set up and maintain. Those of you who may be in that camp – and there are many well-informed, active investors who are members/followers of the Stock Gumshoe site (especially the Irregulars) that just discard the concept out of hand due to that very simplicity. Bottom line is that the theory behind the portfolio management philosophy it uses has both its fans and its detractors.

The thing of it is this…reading about the way stocks are selected for inclusion in the portfolio, the manner in which they are “managed,” and the historical results derived from following this process, is just that: reading. But when put into actual use, it usually doesn’t take long to find out that there is a lot more to it than meets the eye. If ever anything in the investment arena has met the truth behind the Peter Principal that states, “Nothing is as easy as it looks. Everything takes longer than you think. And if anything can go wrong, it will, and at the worst possible moment,” this could at times be it.

In this part one – which will be followed next month with part two –I am going to take you a lot further into this idea than other sites that focus on it tend to do. We’re going behind the curtain so to speak to see what actually occurs once an investor sets up his/her initial portfolio and the wheels began to turn. You’ll see that indeed, “Nothing is as easy as it looks.” And, “Everything takes longer than you think.” And sometimes, “If things can go wrong, they will, and at the worst possible moment.” I think you will find this to be an interesting journey of enlightenment about the Dogs of the Dow and how they just might have a place in your portfolio management systems.

Before I get to the heart of this, a bit of disclosure on my part is in order. I discovered this process in 1991. I began to actively use it with clients in 1992. I still use it on a personal basis today and keep something on the order of 15% of my personal investable assets in an account that holds only these positions. And last, yes, I am a proponent of the system and would recommend anyone give it serious thought as to becoming one way to manage a part of your overall financial assets. The “why” of that is coming later in this article. I only ask you pretend you’ve never heard of it before right now and open your mind to the possibility that maybe, just maybe, it could work for you.

That groundwork now laid, lets get this party started.

Who Let the Dogs Out?

It was summer 1991. I was in my seventh year as a Financial Advisor and had just been recruited to join UBS PaineWebber and move away from Merrill Lynch. My business had grown and I was feeling good about that. But at the same time I realized there was something lacking in my business plan to keep growth on track. I had begun to talk with some of the more successful and seasoned brokers about how they had managed to break through the “glass ceiling” of good-but-unexceptional production levels and on into those lofty heights that marked a truly successful FA. And what began to emerge was the idea that almost every one of them had developed some niche of product expertise that they could offer prospects and clients which few, if indeed any, other brokers could. It might have been managed accounts, or option trading, or muni bonds, or equity dividend approaches, or small business retirement plans – you name it. Sure, all of us could offer advice on any of these topics, but these brokers were different. They had dedicated themselves to that field of knowledge and went after it with a focused passion. They knew a lot about a little, and a little about a lot. I had been working with the idea that the way to excellence was to put the “know a little about a lot” part of that phrase first in priority. I was wrong. And I realized I had to find my specialty, the one thing I could learn more about than anyone else knew, and make that the centerpiece of my business. And from that I could branch out into other areas of need of the client. But what? What could I do that wasn’t already being done by many others?

That was when fate intervened.

I was reading some financial magazine one day and ran across a book review that caught my eye. There was a new financial book that had recently hit the shelves of booksellers entitled Beating the Dow. It was by Michael B. O’Higgins, an independent Investment Manager who ran his own firm, O’Higgins Asset Management, Inc., in Miami Beach, FL. He had done extensive research on a novel way to construct and run an equity portfolio that he called “The Dogs of the Dow.” I stopped by a local bookseller that evening, got a copy, and was up all night reading it.

I was hooked. Here was, I felt, my niche.

Note: You can still obtain a copy of the original book Beating the Dow by O’Higgins as well as his updated version, Beating the Dow; Revised Edition by going to the Barnes & Noble website. The original book is offered by various sellers for about $4.00 and the new edition is about $13.00. Plus S&H and tax of course. Anyone interested in this investment management theory would be well served by obtaining a copy of each and reading thoroughly.

It may seem simple today given all the coverage and widespread information about the Dow Dogs Theory that exists for me to have become so excited about it. But you have to remember, this was late 1991. Nobody, and I mean nobody, had even much heard of this technique much less be using it in one format or another as a way to run a portfolio. That was key to me. I could make it my own and not be concerned about having to compete with every broker and brokerage house on the street for clients that were suitable for it and interested. That would change over the ensuing years, but for that moment I had nothing but open ground in front of me. After spending some time doing my own back testing and examination, and finding that yes, indeed, the process did lead to returns that beat the DJIA most years plus having average annual returns of 5 – 10 – 20 years that were superior to the inde