If you’re unaware, there’s an investment strategy that borders on the simplicity of index investing. It’s called The Dogs of The Dow, and it involves an investor simply buying the 10 highest yielding Dow 30 stocks and holding them from January 1st to the end of each year, resetting the portfolio every year. According to their website, the dogs of the dow strategy has returned 17.7% annually from 1973 to 1996, while the Dow Jones industrials have returned 11.9% for the same period. Performance for the years 1996-2009 is only kept on a year to year basis, and upon first glance doesn’t seem that impressive. Let’s have a closer look:

Year        Dogs Performance        Dow Performance
1997                17.3%                               22.6%
1998                10.7%                               16.1%
1999                  4.0%                               25.2%
2000                 6.4%                                -6.2%
2001                 -4.9%                                -7.1%
2002                  -8.9%                            -16.8%
2003                 28.7%                             25.3%
2004                    4.4%                                 3.1%
2005                   -5.1%                              -0.6%
2006                  30.3%                            16.3%
2007                    -1.4%                             6.4%
2008                    -41.6%                       -33.8%
2009                      16.9%                         18.8%
Totals                    56.8%                         72.3%

*Note: The returns for the DJIA do not include dividends, making the dogs strategy even less impressive over the past years.

As my sloppily made chart indicates, the strategy has been less than impressive since 1997. The Dogs portfolio stuck with names such as Eastman Kodak and Citigroup, giving these companies large positions in the portfolio while these companies had their weighting in the Dow Jones industrial average diminished.

Astute investors can find another problem with the theory. The Dow is viewed as an imperfect index because of the weighting system and the fact it only includes 30 stocks. While the performance of the Dow and S&P 500 has been fairly similar over the years, investors have moved to viewing the S&P 500 as a better indicator of the performance of the overall market.

What if we took the dogs of the Dow strategy and applied it to the S&P 500? Would we get a better performance with more stocks to choose from? Would a bigger pool of stocks give the strategy better performance, or would the strategy under-perform because certain dog stocks would spend more time lingering around the S&P 500? (Think General Motors, Chrysler, all sorts of banks)

Fortunately for us, someone is already doing this. Over at Marketocracy, someone has been testing out this theory for the past 5 years. While 5 years is a pretty good amount of time, I’m not entirely comfortable with it being a suitable period of time to test the viability of an investment strategy. It’s still a good place to start. The verdict?

During the period, the fund is up 12.6% while the S&P 500 is up 10.46%. It does not appear either of those numbers include dividends, so if you add in the high yields of the dogs, you would have a decent performing fund. Marketocracy says the theory has outperformed 55% of funds on their site over the past 5 years, a rock solid performance. I’ll be keeping an eye on this one.

As an aside, Marketocracy is a pretty cool site. The Uproar Fund may be hosted there.

Tell everyone, yo!