Q. The Dogs of the Dow investment strategy seems about as easy as using the Couch Potato Formula. I realize one of the points of the Couch Potato is to keep costs low. There are low cost traders out there that could reduce the expense of a Dogs portfolio. The worst-case scenario for the Dogs would be to sell all ten equities and buy ten new equities. That rarely happens, helping to reduce the costs if you manage it by yourself.

Another advantage of the Couch Potato is broad diversification. The Dogs have some diversification, though only in large cap stocks.   This is a drawback. However, maybe the contra-investing aspect makes up for this weakness. I would like your comments on the Dogs. Would you answer the following questions?

First, how do the returns of the two strategies compare over the long term--- 10 to 20 years? Second, are there funds, ETFs, or other mechanisms that could be used to follow the Dogs strategy? Finally, does it make sense in anyway to mix the Dogs strategy with the Couch Potato, perhaps reducing bond holdings in a 60-10-30 (equities-Dogs-bonds) formulation?

---B.R., by e-mail

  

A. You can find the mother lode of Dogs of the Dow information at the website by that name, www.dogsofthedow.com. For readers who haven't heard of this investment method, the "Dogs of the Dow" strategy is simple.   Buy the ten Dow Jones Industrial Average stocks with the highest dividend yields. Do it each year. Continue holding until they no longer make the top ten-yield list.

The Motley Fool had a number of variations on the original Dogs and there is always   "the small Dogs of the Dow," in which the investor buys the five Dow Dogs with the lowest prices.

Basically, the Dogs of the Dow strategy is large cap contrarian investing. It is a simple way to have a "yield tilt" portfolio. Currently, for instance, the 10 Dogs yield an average of 4 percent, more than twice the yield of the S&P 500. The current Dogs are Phillip Morris (now operating under the assumed name of Altria but retaining its old ticker, MO), J.P.Morgan Chase, General Motors, Eastman Kodak, SBC Communications, Dupont, Honeywell, General Electric, Caterpillar, and AT&T. (It should be noted that Kodak just announced a major dividend cut.)

In the three years of the bear market, the Dogs of the Dow beat the S&P 500 soundly. If we compare the Dogs with the S&P 500 over four years of roaring bull and three years of bear--- the 1996 through 2002 period--- the total return of the Dow Dogs was 166.8 percent versus 159.2 percent for the S&P 500. This advantage could easily have been lost to transaction costs.

Over still longer periods, there seems to be a larger advantage but, again, transaction costs (and possible taxes) have not been considered.

With discount brokerage commissions, you can do the Dogs pretty inexpensively. The minimum "silver" level commission at Fidelity, which requires a $100,000 account, is $15. A year with 100 percent turnover, therefore, would cost about $300 in commissions. The average domestic equity fund with at least $1 billion in assets has an expense ratio of 0.97 percent, according to Morningstar. This means you could run your Dogs Fund for less than a major mutual fund on a total investment of   $30,982 or more. Since mutual fund expense ratios don't include their trading commission costs and few years will have 100 percent Dogs turnover, it doesn't take much to beat the costs of the big funds. Indeed, if you invest $166,667 in the Dogs you'll have lower expenses than the 0.18 percent expense ratio of the Vanguard 500 Index.

Sorry, proliferation of Exchange Traded Funds notwithstanding, there isn't one for the Dogs of the Dow. From time to time, brokerage houses have offered unit trusts that invest in the Dogs of the Dow, however.

Does it make sense, in any way, to mix the Dogs with the Couch Potato?

Yes, following the 2003 tax cut. As I have pointed out in other columns, stock dividends taxed at 15 percent are worth more than identical bond yields taxed at higher rates. Currently, for instance, the 10-year Treasury yields 4.10 percent. For investors in the 25 percent tax bracket that means an after-tax yield of 3.08 percent. A Dogs of the Dow investor, who currently receives 4.05 percent pre-tax, would have an after-tax yield of 3.44 percent. The comparison will be even better for investors in higher tax brackets.

Would I cut the bond allocation to 30 percent of a portfolio?

Perhaps. It could be argued that high yield stocks, which are taxed at lower rates, are near-bonds.