Thursday, January 1, 2015

commission-free dogs

this time of year you will hear about the dogs-of-the-dow strategy for investing. this is because dotd strategy revises its list of dogs on jan 1.  dotd picks the top-10 yielding dow stocks on jan 1 and invests equal dollar amounts into each. at the end of the year one sells the stocks that are no longer dogs and buys the new dogs. 

the simple concept behind dotd is that since price and yield move inversely to each other, then, the highest yielding stocks are in some sense priced cheaply and will eventually get bid up to an average yield for the dow ... in theory. in practice, this strategy has a checkered past, with some years of outperformance and others of underperformance and thus represents no particular investing magic but as an engagement tool is still valid, except that you need some money to start with.  you will need to deploy a minimum of a $1000 for every stock to reduce the impact of commissions to 1% or 2% to even have a fighting chance of making money. so implicit in this strategy is that one already has $10,000 sitting idle in a brokerage account.

at smalldog investor i like to show how one might start with almost nothing and methodically build up invested wealth by application of investing knowledge and technique. at tdameritrade (my brokerage and the one that is friendliest to small investors) there is a list of etf's (exchange traded funds) that can be traded for zero commissions, provided one holds shares for at least 30 days (there is an online agreement that must be signed in order to participate; signup is free.) some of these commission-free etf's pay a substantial dividend, like between 5% and 7%. so one could apply the same dotd logic to this list of commission-free etf's - list them in decreasing order of yield and invest in the highest yielding ones. this looks like:
tda commission-free dogs
the difference now is that one can buy these etf's efficiently in sizes as small as 1 share (and i have.) why not? there's no commission. so if one has an extra $20 a week to spare, one can start buying ewu, the etf that represents ownership of british stocks, and make almost 8% in dividends.

what's more, one can scale-into these etf's 1 share at a time. the biggest fear that a yield chaser has is that a decline in share-price will offset the dividends collected, but, one could simply buy additional shares to efficiently dollar-cost average. 

if price increases, the yield will drop for additional shares purchased but your original shares purchased at high yield will continue to yield that original rate, so long as the dividend remains the same. thus, one could stop buying the etf's that have declined in yield and maybe start purchasing new etf's that have increased in yield. i recommend revisiting this frequently, preferably weekly but monthly or quarterly will do.

as dividends start coming in they will increasingly offset the cost of shares being acquired. eventually, one will get to the point where the incoming dividends pay the whole cost purchasing shares and the process becomes self-sustaining. with the ewu, for example, yielding 7.8% and a share price of $18, owning 231 (=18/.078) shares will pay for 1 additional share per year. 52x that (~12,000 shares) will pay for an additional share per week.

this is a kind of a diy drip (dividend re-investment program) the difference being that you control when the re-investment occurs and you can cross pollinate. that is, use the dividends from the old high-priced ex-dogs to help pay for the new dogs. 

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