Hot to Play Dow 10K? Here Are Some Ideas

Everybody quotes the Dow Jones industrial average as the preeminent symbol of the U.S. stock market.

But what about owning the Dow itself--as a diversified portfolio of stocks?

The century-old index’s recent flirtation with the historic 10,000 mark has garnered the Dow even more publicity than usual, worldwide.

And unlike even a decade ago, there now seem to be 10,000 ways for the average investor to play the 30-stock Dow.

But should you?

Here’s what the numbers show: For the 10 years ended last Dec. 31, the Dow’s total return (price gain plus dividends) was 458%.

That was far better than the 343% earned by the average general U.S. stock mutual fund in that same period, according to fund tracker Lipper Inc. in New York.

But the Dow has lagged its broader, if less quoted, brother, the Standard & Poor’s index of 500 blue-chip stocks. The S&P; earned 480% in that 10-year period.

Likewise, the S&P; has beaten the Dow over the last five years and two years.

This year, so far the Dow has turned the tables, even though at 9,890.51 on Monday it is slipping further from the 10,000 mark: Including dividends, the Dow is up 8.2% since Dec. 31, versus 5.8% for the S&P; 500.

The Dow also can claim this distinction: It held up better than the S&P; in the last three calendar years when the market took a major tumble--1987, 1990 and 1994.

If, for whatever reason, you think the Dow or some variation is worth owning going forward, here are some ideas:

* Straight Ahead: Two no-load index mutual funds attempt to track the Dow.

ASM Index 30 (telephone: [800] 445-2763), launched in 1991, is the granddaddy. Through March 11, it earned a respectable five-year annualized return of 20.1%, according to Lipper, versus 23.3% for the Dow itself with dividends reinvested.

The 1-year-old Waterhouse Dow 30 Fund ([800] 934-4443) boasts in its ads of being the only no-load index fund licensed to use the Dow name, though that doesn’t seem to give it an edge when it comes to performance. It and the ASM fund both returned 8.1% this year through March 11, according to Lipper, nearly matching the 8.2% return of the index itself.

But Morningstar Inc. analyst Scott Cooley says that investors who specifically want to buy an index stock fund for the long haul would probably do better owning a fund that tracks a broader index than the 30-stock Dow.

“Such a narrow slice of the market takes away the advantages of diversification,” he says. “An S&P; 500 fund or the Vanguard Total Stock Market Fund [which tracks the all-inclusive Wilshire 5,000 index] has more appeal to me.”

* Different Animals: Two no-load funds follow the “Dogs of the Dow” investing theory, which calls for buying shares of the 10 highest-dividend-yielding Dow stocks--generally, the most beaten-down of the 30--and rebalancing the portfolio every year.

Payden & Rygel Growth & Income ([800] 572-9336) and O’Shaughnessy Dogs of the Market ([877] 673-8637) are prohibited from strictly following the strategy because of fund diversification rules, so Growth & Income is half dogs, half S&P; 500 index depositary receipts, while the O’Shaughnessy fund holds the 10 dogs plus the 20 highest-yielding stocks in the mid-cap S&P; 400 index with at least $1 billion in capitalization and an “A” rating from S&P.;

Proponents point to the Dow dogs strategy’s 25-year record of beating the index itself, but it has gone cold in the last couple of years, perhaps because everyone and his dog now knows about it. The O’Shaughnessy fund lost 3.7% this year through March 11, while the Payden portfolio fared better, gaining 4.8%--but both trailed the Dow itself.

Analyst Cooley says the high dividends may make these funds better suited to tax-deferred accounts such as IRAs or 401(k)s.

“A taxpayer in the top bracket could easily end up paying 40% of the dividend payouts to the tax man,” he said. And every year, he notes, the fund manager sells your winners as the fund rebalances its portfolio, chucking any non-dogs, and “that creates a taxable event.”

Several brokerages, meanwhile, offer unit investment trusts in the Dow dogs. These trusts aren’t bound by the same diversification rules as mutual funds, so they’re pure canine, but they also carry high management fees, often around 2% of assets annually.

* A “Value” Variation: The no-load Strong Dow 30 Value fund ([800] 368-1030), launched in 1997, has a “Dow dog element,” as co-manager Charles B. Carlson puts it, but dividends are just one criterion he uses to “overweight and underweight” the 30 stocks based on perceived value. Price-to-earnings ratios and other stats go into the mix.

“Dividends are less and less significant now as companies turn to stock buybacks instead” to return cash to shareholders, Carlson said. The fund earned 8.5% this year through March 11, edging the Dow, and 14.6% in the previous 12 months, trailing the index’s 16.3% return, according to Lipper.

* The Direct Approach: Of course, you can buy individual Dow stocks through any broker, but Carlson notes that 29 of the 30 companies in the Dow offer a dividend reinvestment plan or direct purchase option. Citigroup is the only holdout, according to Carlson, who also edits The DRIP Investor newsletter.

DRIPs and direct purchase plans allow investors to buy even small amounts of stock through a clearinghouse or the company itself, usually for low commissions. Carlson’s list of “DRIPs to Watch in 1999” includes Dow members AT&T;, Coca-Cola and Walt Disney. His Web site (https://www.dripinvestor.com) and competitor The Moneypaper (https://www.moneypaper.com) offer information on this method of investing.

* Jewel Hunting: The American Stock Exchange offers “Diamonds” based on the Dow index. This security (ticker symbol: DIA), launched in January 1998, represents an investment in a trust that mimics the Dow and is priced at about 1/100th of the index’s value. (Monday’s close: $99.13.)

The Amex pioneered index securities in 1993 with the popular SPDRs (“Spiders”), depositary receipts based on the blue-chip S&P; 500. Diamonds trade like a regular stock and pay dividends. For information, visit https://www.amex.com or call (800) 843-2639.

* Other Options: The Chicago Board Options Exchange offers “put” and “call” options on various Dow averages, including the industrials. Options can be used by aggressive investors as a bet that a security--or in this case, index--will go up or down. They also can be used by conservative investors as a way to hedge a portfolio against loss.

A put option gives the buyer the right to sell a security at a specific price and by a specific date; the holder can profit if it drops in price. A call option grants the right to purchase a security at a certain price by a set date; the holder can profit if it moves up in value.

For information, visit the CBOE Web site at https://www.cboe.com or call (800) OPTIONS (678-4667).

The CBOE also offers options on the Dow dogs (ticker: MUT). For specifics visit the CBOE Web site or call the CBOE at the phone number above.

The Chicago Board of Trade offers futures and options contracts based on the Dow. A futures contract is an obligation to buy (a “long” position) or sell (a “short” position) a specific commodity--in this case, the basket of Dow stocks--by a settlement date. For information visit https://www.cbot.com or call (312) 435-3500.

Josh Friedman can be reached by e-mail at josh.friedman@latimes.com.

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Battle of the Indexes

So far this year, the 30-stock Dow Jones industrial average is outperforming the much broader Standard & Poor’s 500 index. But over the 10-, five- and two-year periods ended Dec. 31 of last year, the S&P; 500’s gains were significantly better than the Dow’s. Here are total investment returns for the two indexes (price gains plus the value of reinvested dividends):

Sources: Lipper Inc., Bloomberg News