How Dividend-Paying Stocks Can Help You Tame the Bear

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By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Many investors are so scared by the wild gyrations the stock market has seen of late that they've jettisoned everything – including the kitchen sink – in their search for safety.

Not only is this a massive mistake from a timing standpoint, it's also a major misstep because of all the dividend income those folks are going to forego. Taken together, investors who have embraced this kind of "abandon-ship strategy" will find that they've dealt themselves a one-two knockout punch that will put their portfolios down for the count.

Let me explain …

Dividends are the Key to Profits

Giving up dividend income is never smart, but it's an especially egregious error during messy markets like the one we're navigating now. Research shows us why. For instance, studies show that:

  • Dividend-paying stocks tend to be more stable than their non-dividend paying brethren – particularly during rocky stock markets. In other words, stocks that have income streams attached are treated better, especially when the going gets tough.
  • Dividend-paying stocks outperform non-dividend paying stocks by even more in down markets than they do in up markets.
  • By consistently reinvesting dividends during down markets, investors can substantially expand their asset base, which puts them way ahead of the game when markets recover and stock prices soar – as they always eventually do.

The concern, however, is that we're swirling down into a recession. Maybe we are. Maybe we're not.

Either way, we've been here before. And this malaise – no matter how bad it gets – will pass. Just think about where we've been: There was the Price/Earnings (P/E) Ratio peak crash of 1901; the Great Crash of 1929, the "Black Monday" stock market crash of October 1987, the Asian Contagion of 1997, loan defaults in South America and Russia, and even then 9/11 terrorist attacks.

Each of these ultimately passed.

And each time, dividend-paying companies led the way higher. And the savvy investors who owned them watched as their own portfolios easily outperformed the market averages, and roundly trounced the returns of portfolios that were light on dividend-paying shares, or that excluded those income-oriented shares altogether.

The Numbers Tell the Story

According to Ned Davis Research, dividend-paying stocks provided returns of more than 10% a year from 1972 to 2005 [and keep in mind that this research study started at the worst possible time in the past 40 years – just prior to the "bear market" of 1973-1974, which dragged on for 21 months and caused shares to lose 48.2% of their value. Non-dividend paying stocks, in contrast, posted gains of just 4.1%.

Think of it another way: An investment of $1,000 in a portfolio of dividend-paying shares during the period covered by the study would have turned into $2,629; that same $1,000 invested in non-dividend-payers would have turned into $1,598. In other words, the dividend-paying portfolio was 65% larger than the non-dividend paying portfolio.

When separated into three groups – rising-dividend-payers, static-dividend-payers, and non-dividend-payers – the difference is even more dramatic over the timeframe in question.

The returns on stocks that are boosting their dividends were more than four times the returns of non-dividend-paying stocks. The rising-payout shares also outperformed the static-dividend payers by 136%.

According to Yale University's Robert Schiller, Wharton Business School's Jeremy Siegel and other noted researchers, the advantage that dividend-paying stocks can have over non-dividend payers can be as much as 25:1, depending upon the time frames studied. Dividends can account for as much as 97% of a stock's total return.

To understand the advantages dividends can provide an investor during a down market, let's take a look at the implosion of the dot-com bubble in 2000.

According to Morningstar research, the Standard & Poor's 500 Index lost 9%, while dividend-oriented mutual funds – including high-yielding stocks in the financial-services, mutual-fund and real-estate sectors – gained anywhere from 10% to 30%.

Fast forward again to include both the dot-com decline and the subsequent recovery through last summer:  Once again, dividend-paying stocks continued to outperform non-dividend-paying stocks by a wide margin.

There's a very good explanation for this out-performance: Dividend-paying stocks feature a much lower "beta," meaning that they are less volatile than the overall stock market. Granted, the downside to this is that dividend-paying stocks don't accelerate as fast as, say, non-dividend paying growth stocks in a broad-based bull market. But unless you're a hard-core stock trader, that's a fact you really don't need to worry about.

During a 35-year-period that included some really big market downdrafts and bear-market cycles – as well as some highly bullish stretches – a $100,000 investment in static dividend payers in 1972 would today be worth $3.2 million. That same hundred grand invested in dividend-growers would be worth $4 million.

The same investment in non-dividend-paying stocks would be worth a paltry $240,000.

Again, the period in question started at one of the most inopportune times investors have been forced to face in modern history – just before the start of the '73-74 bear market.

The Moves to Make Now

Regardless of how appealing this strategy sounds, you don't want to rush into anything -not even dividend-paying stocks.

The key reason: It's very possible that the current stock-market downdraft will continue.

Therefore, it makes sense for you to ease your way a little at a time into dividend-paying shares – and any other specialized investment vehicles that we detail for you in the stories and investment reports we present here in Money Morning. One of the simplest ways to accomplish this "steady-as-she-goes" strategy is to simply to allocate your capital into equal parts and invest it in equal amounts over the next three months to six months.

And there are some excellent investment candidates. Two of the best are the PowerShares International Dividend Achievers Fund (PID) and the Alpine Dynamic Dividend Fund (ADVDX), two exchange-traded funds (ETFs) that we like a great deal.

The PowerShares International Dividend, or PID, fund is a global-income portfolio that can help you spread your risk, while also earning income. The Alpine fund is a more-specialized fund that uses a "dividend-harvest strategy" that can boost the fund's yield.

Both funds invest in companies that have survived countless business cycles, and that are likely to survive this downdraft, too.

Because dividend-paying stocks tend to be downdraft resistant, portfolios with higher yields tend to last longer and pay stronger. That's something that's important to all of us, but especially to investors who are nearing retirement, or who have already retired.

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He’s a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean.

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