How to Implement a Dow Dividend Strategy
There are two basic ways to execute a Dow Dividend Strategy: 1)
Buy a Unit Investment Trust from a broker, or 2) Trade
for Yourself in brokerage account. Some of the pros and cons
of each approach are:
Unit Investment Trust (UIT): These are pools of securities
(stocks in the Dow Jones Industrial Average in this case) that
in effect collect money from individuals, buy the stocks in the
strategy, and after a period of time, sell the stocks and distribute
the proceeds to the individual investors. Such pools are passively
managed in that no adjustments are made to the portfolio after
the stocks have been purchased. Typically, the UITs using a Dow
Dividend strategy buy the ten highest yielding Dow stocks at the
end of a month and hold them for one year. If you are interested
in a UIT, you will probably have to contact a "full service"
broker such as Merrill Lynch or Dean Witter. It is also possible
that discount brokers that offer more than the basic services,
such as Schwab or Fidelity, may also sell UITs. However, the costs
are probably the same no matter which broker you use. (These names
are provided for illustrative purposes and should not be considered
as a recommendation to use a particular brokerage firm.) You pay
an up-front fee when you buy a UIT, which is typically 2 to 3%
of the amount invested.
Advantages of UITs include:
- Convenience: You write one check and you are done. The manager
of the trust figures out which stocks to buy, buys them and later
sells them. Also, the trust collects the dividends and sends you
a check every month or quarter.
- Small Investment: The minimum investment may be as low as
$1,000 (or $250 for IRAs). For small investors, the costs of buying a
UIT may be less than the commissions that would be paid to buy
and sell the stocks in an individual brokerage account.
Disadvantages of UITs include:
- Limited Choices: You may not be able to find a UIT that does
anything other than buy the ten highest yields (High10 strategy).
If there is another type (you may need to check with several brokers),
it is likely to be buying the five lowest priced of the ten highest
yielders (BTD5). As the results shown elsewhere on this site demonstrate,
there are more attractive Dow Dividend strategies.
- High Costs: If you have an amount to invest that is somewhat above
the UIT minimum, you probably can buy and sell the stocks yourself,
paying commissions, at lower cost than the UIT fee. There are
now "deep deep discount" brokers that will execute simple
orders to buy or sell for $20 or less. Generally, you have to
place the orders without talking to a broker by using an automated
phone system or your computer, possibly via the Internet. Inexperienced
investors may want to place the first few orders by talking to
a person, which most of these firms permit for an additional fee.
There are also a range of deep discount brokers that allow voice
placement of orders and charge $30 to $50 per transaction. Discount
brokers do not provide investment advice (some do have research
materials they can send you), but since you will have done all
the work necessary to figure out which stocks to buy and sell
as part of a Dow Dividend strategy, you won't need any advice.
Trade for Yourself: Obviously, you will need a brokerage
account to place your trades. Experienced investors who do their
own research and make their own decisions are best off using brokers
who charge the lowest commissions. There are numerous advertisements
in financial publications and on CNBC that can be used to generate
a list for additional inquiries. The Internet is also a source
of leads for brokers. An investor who has never had a brokerage
account and wants to get started with a Dow Dividend strategy
may want a broker with a local office that can provide guidance
in filling out the forms and a personal broker to answer questions.
Several discount brokers, such as Waterhouse, Schwab, and Fidelity,
have offices in the larger metropolitan areas. These firms and
others also have a wide selection of mutual funds that can be
bought and sold with no transaction fees should the investor wish
to diversify in this manner. The advantages and disadvantages
of UITs discussed above are respectively disadvantages and advantages
of doing your own trading.
Additional potential advantages of trading for yourself include:
- Tax Advantages: If you follow my recommendation and execute
your strategy by trading around the beginning of the year, you
can time the sales for a tax advantage. Usually, but not always,
this means selling losers in the current year and deferring the
sale of winners until the following year. It may be possible to
generate short-term capital losses in one year and long-term capital
gains in the next year, which are the most tax-favored outcomes.
- Holdover Stocks: It is common for some of the stocks purchased
according to a Dow Dividend strategy to be part of the strategy
in the following year. A UIT, in effect, sells all stock at the
end of its holding period and then repurchases some of them if
the investor rolls over into another UIT. In your own brokerage
account, you can just hold onto the holdover stocks. If you do
not "rebalance," then there is a commission savings.
Moreover, if you have a gain in a holdover stock, by not selling
it, you do not realize the gain and generate a tax liability.
- Margin: If you are aggressive, you can open a margin account
with your broker (but not in a retirement account), which enables
you to buy stock with a value of up to twice the amount of money
you put into the account. Buying on margin increases leverage
and profits if the portfolio increases in value, but at additional
cost and risks. The amount of stock not paid for is a loan from
the broker on which interest is paid. If the value of the portfolio
drops by too much, the broker will require you to add money or
securities to your account (a "margin call") or will
sell some or all of your holdings, with or without your consent.
Being forced to sell can negate the benefits of a Dow Dividend
strategy and could turn a potential winning year into a losing
There is at least one potential additional disadvantage to doing
your own trading:
- Discipline: Executing a strategy that is based on formulas,
like the Dow Dividend strategies, requires the discipline to stick
with your plan and not abandon it during the year because "it
doesn't feel right," or "I am scared about what the
market is going to do," or some other emotional reason. With
a UIT, you are "stuck" with the strategy until its holding
period is up, but you can place an order to sell in your own brokerage
account any day the market is open. If you decide to follow a
version of the Dow Dividend strategy, you should stick with it
for at least a year, and probably for several years before deciding
that it is not right for you. There is a real temptation to try
to "time the market" by selling when you think the market
or some of your stocks are about to fall. You will believe that
this indeed will happen and you will be able to buy back at lower
prices. This is very difficult to do consistently, and most investors
will decrease their returns by trying. One of the beauties of
these strategies is that they don't require intervention or judgment
about what the market will do. Over time, they work, so just stick
to them. The temptation to trade the stocks during the year will
be even greater if you have an account with a "full service"
broker whose account representatives provide investment advice.
These reps make their money from commissions and have an incentive
for you to trade frequently. Normally, they will call you every
so often with another idea or some reason why you should sell
some of the stock you already own. ("It is up 20% already,
which is very good, and you won't go broke by taking profits.
Our research department shows that it is now 'fully valued' so
you should switch to XYZ, which we think has the potential to
go up by 25% over the next six months.") Some brokers may
well have your best financial interests at heart, but most are
just trying to generate commissions. If you use a full service
broker, make it clear that you are following a strategy, which
you will explain to him/her, and that you do not want to trade
until the strategy calls for it. A good representative will understand
your wishes and not suggest selling until the strategy calls for
it. One advantage to a discount broker is that their representatives
are order takers on salary, so they will never call to suggest
that you buy or sell.
Recommendation: If you have less than $10,000 available
for investment according to a Dow Dividend strategy, buy a unit
investment trust. If you have $10,000 or more, open an account
with a deep deep discount broker and make your own trades. If
you have $10,000 and use a strategy involving five stocks (such
as BTD5), and if the broker charges $20 per trade, then the commissions
for one year will be $200 ($20 x 2 x 5), which is 2% of your capital.
If you are more aggressive and use the MF4 strategy, which involves
four stocks, then the commissions are about 1.6%. Assuming that
you will continue using the strategy for more than one year and
that some stocks will be holdovers (which is quite likely), if
you do not rebalance at the end of the year, then your commissions
will be a smaller percentage over time. If you have more to invest,
say $20,000 or more, than my preference would be to use the two
year combined strategy that calls for investing approximately
equal dollar amounts in each of the stocks in the combined current
year and prior year BTD5 lists. Do not worry about buying "odd
lots" (other than a multiple of 100 shares) since there is
no longer any penalty or execution disadvantages for such trading.
As explained elsewhere, the best time to execute these strategies
is right around the beginning of the year. If it is late in the
year, say after August, I would just wait to get started. If you
do the calculations, you may be able to see that some stocks are
virtually certain to be part of your strategy, so you can buy
them whenever you think is a good time. (Example: After the market
takes a sharp drop or even "crashes." November 1987
would have been a great time to start buying.) If you are using
the two year combined strategy, you will already know five of
the stocks for the portfolio: those on the current year's BTD5,
which will be next year's prior year list! Earlier in the year,
you could buy based on the current rankings and calculations.
Another possibility, which is attractive if the market is down
so far in the year, is to buy the stocks you would have bought
at the beginning of the year. That way your results will be better
than if you had started at the beginning of the year according
to your chosen strategy. There is no magic right answer. The important
thing is to formulate a plan and then stick with it for several
years. Doing so should enable you to realize the benefits from
following one of the Dow Dividend strategies.
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