Journal of Investment Strategies

Lifecycle investing with the profitable dividend yield strategy: simulations and nonparametric analysis

Wai Mun Fong

  • Previous research shows that a life-cycle investment (LCI) strategy is sub-optimal compared to a lump-sum investment (LSI) strategy that fully invests in the market portfolio right from the start.
  • We show that LCI is not doomed if this strategy is applied to stocks with high Sharpe ratios and high geometric mean returns.  
  • An important class of stocks with these features consists of highly profitable firms that pay high dividend yields (in short, PDY stocks).
  • Using simulations and nonparametric tests, we show that LCI with PDY stocks outperform both LCI and LSI implemented on the market portfolio.

A common piece of advice given to young investors is that they should invest a high percentage of their wealth in stocks when they are young and progressively switch to bonds as they age. Critics argue that this life-cycle (LC) approach is suboptimal compared with a strategy that is fully invested in a diversified market portfolio. Using simulations, we show that LC investing implemented on highly profitable and high dividend yield stocks (the profitable dividend yield strategy) provides a compelling solution to the suboptimality problem by leveraging on the strategy’s high average return and outstanding Sharpe ratio compared with a market portfolio.

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