Protect Your Dividend Stock Investing Profits from Crisis
It may take 6 to 26 years for a dividend stock to recover after you invested in it.
Here you find 3 tactics that you can choose from when you invest in dividend stocks and a stock market crisis may lie around the corner. Imagine that you are investing in Procter & Gamble; one of these well-known dividend stocks and one of the 30 stocks in the Dow Jones.
Do you know that it took the P&G stock 6 years to recover from the dot.com crash in 2000? And are you aware that it took the Dow Jones 26 years to recover from the Great Depression in 1929. Currently we hear a lot of talk about a next great recession. Nobody knows if that will happen or not. But how do you protect your dividend stock investing profits in times of potential crisis?
Market crashes rob you from all the dividends that the stocks pay you. Yes, you still get dividends paid when markets go down. But to see this dividend as a profit, you must be able to hold the stocks till after they have recovered. This could take 6 years, but also sometimes 26 years.
Suppose that you have to or want to sell a dividend stock 5 years after a market crash. Imagine that at that moment it is still 15% below the price you bought it for. Suppose that you got 4% in annual dividends. You got thus 5 times 4%, which is 20% in dividends. But you also lost 15% on the stock price. Your net gain for 5 years is only a meager 5% (20% minus 15%). That is only a 1% annual return on investment; less than on a savings account.
Lower Dividends during Bear Markets
Now there is something else. Have you ever seen a market crash and bear market when the economy is doing well? No, in most cases stock markets go down significantly when the economy is in bad weather. And when the economy is not doing well, companies make less profit and… pay lower dividends.
Thus a company may still pay 4% dividends, but that is 4% of its stock price at that moment. Suppose that the stock price is now 30% lower than the price that you paid. Then the dividend you receive is only 2.7% of the price that you paid and not 4%. Thus even when you can keep your dividend stocks till after the stock price has recovered; you still get a lower return on investment than originally hoped for.
The above is both valid for when you invest in individual dividend stocks or in a fund that invests in these dividend stocks.
3 Tactics when Dividend Stock Investing
You can choose from the following 3 tactics when investing in stocks for dividends and a crisis lies potentially around the corner:
- Don’t care;
- Trend Following.
The first choice is the easiest when you have the stomach and time for it. You just hold the stocks or funds and don’t sell… even if you have to wait 26 years. You also accept that the annual return (dividend) on your investment is much lower for many years than originally expected. But if you can afford it and you don’t care, this approach can give you peace of mind.
The second choice you have is to hedge against a down turn in the stock price. This is like insurance. You could buy some put options or some other financial instruments like Turbos or Speeders to short the stocks or index funds that you have bought. When the market falls, these instruments increase in value and cover the losses from the price decline in your dividend stocks.
The disadvantage of this approach is that it can be expensive and consume a part of your dividend earnings. Once the market crash has happened or the major threat of a crisis has gone away, you can sell the insurance again and continue as before.
The advantage of the hedge approach is that it gives you the flexibility to sell your dividend stocks earlier than that their price has recovered without taking a loss on it. And if you sell your insurance after the market has crashed and you invest these gains in additional dividend stocks, you can make even extra profits. But this is getting very close to your third option.
Trend Investing for Dividend Stocks
The third choice you have is to practice a combination of dividend stock investing and trend following. With this tactic, you invest and hold your dividend stocks or funds as long as the long-term trend direction for the stock market index points up. When the long-term trend starts to point down, you sell your dividend stocks. When the trend starts to point up again, you buy the dividend stocks or funds again.
On average, the long-term trend in a stock market changes direction only once in the two or three years. The assumption for this approach is that the stock price declines much more in value than the income you would have got from the dividends that are paid out during longer bear markets. When markets can fall more than 30% and annual dividends are less than 4%, this seems like a sound assumption.
To see an example of what the long-term trend direction is at this moment, click here to go to our latest long-term trend signals for the S&P 500.
The disadvantage of this approach is that you need access to (or have your own) reliable indicators for the change in direction of the long-term trend. Furthermore, you would need the discipline to check on a monthly basis what the long-term trend direction is and act accordingly. A final disadvantage of this approach is that you would need to accept that no single trend indicator is always right. Sometimes you go in the wrong direction and have to correct.
To get a solid understanding of the different trend indicators, please click here to read the free guide to our long-term trend following signals.
One advantage of combing dividend stock investing and trend following is that you pocket the dividends when they are the highest: during the bull markets. The other advantage is that you increase the number of assets you hold in the end by selling at the beginning of the bear market and buying for a lower price at the beginning of the bull market.
Market crashes and bear markets can rob you from the profits that dividend stock investing can provide you with during markets that move up or sideways. Here you have found 3 different tactics that you can use when investing in dividend stocks while a recession maybe looming. Which of the 3 tactics appeals most to you? Please comment to share your thoughts or ask any questions.