If I had a dollar for every time I heard or read the word recession in the last week, well, I’d have enough not to be financially worried about one. Add a dollar for every mention of tariffs and I’d be comfortably flushed with cash.
These will definitely be the buzzwords through Q2, and I’m betting through the end of the year. Whether we experience an “actual” recession or not, I’m certain this year will bring a level of discomfort to both consumers and investors. You can see uncertainty everywhere and both groups will feel it.
The wild market swings we’ve seen over the past two weeks, unfortunately, are just a taste of what I expect to see this whole year. How frayed your nerves get in reaction to choppy markets should be directly related to when you plan on selling your shares.
Stock prices go up and stock prices go down. If you own the right dividend stocks, you can relax and just keep collecting your steady payments the whole time. If you’re like me, you’re even buying more shares on down days to lower your cost basis—and boost your yield.
Ride Out the Storm with Dividends
Dividends have historically been much less volatile than stock prices. Stock prices move with media news and headlines, investor sentiment, and algorithm-based trading. Dividends are different. They are commitments to shareholders made by the Board of Directors.
But let’s not be naïve here. Common share dividends are not guaranteed by any stretch of the word. They can be changed at any time based solely on the whims of a company’s Board. However, a lot more needs to happen than just an active news day before a Board decides to cut or suspend its dividend.
We know that all dividends are not safe. During the financial crisis of 2008-2009, about one in three S&P 500 dividend-paying companies reduced their dividends. It took until 2012 for those annual payments to recover.
In 2020, roughly 187 US-listed companies suspended or cut their dividends. Many of them have since been resumed, but the COVID impact on dividend payments continues for some companies through today.
The safety and quality of a dividend matters. You can use a metric like the payout ratio to quickly know if your dividend might be at risk. When a payout ratio approaches 100, we need to see the company increase its profits soon to maintain that payout level. But don’t forget that companies like BDCs and REITs will have a high payout ratio due to the structure of their business.
Know Your Risk and Timeline
Not all dividends are created equal. Safer dividends tend to be smaller, while larger dividends tend to be more risky. Knowing which type of dividend investment will meet your needs comes down to holding time and risk.
It’s easy for me to keep pounding the table about buying the dips. I’m in my mid-30s and have many years before I will rely on my investments. And that’s if I ever choose to stop writing. During times of uncertainty my two-prong approach to dividend investing becomes even more important.
I talk about two types of dividend stocks: Bedrock Income and Current Yield. The first group is used for reinvesting the dividends and building long-term future wealth. The second group generally has a higher yield and is used for generating passive streams of income needed today.
Everyone can benefit from the power of compounding by reinvesting their dividends. And compounding really takes off somewhere between 7-12 years.
Bedrock Income stocks are lower risk, but also generally have lower yields. Buying on dips helps to lower your cost basis and raise your yield. Their stability can work in favor of investors with both a long and short time horizon. If you need to live off your dividends now, these will be less volatile. If you have more time, these are a set-it-and-forget-it way to build wealth.
Bedrock Income companies also tend to be recession resistant. Meaning that no matter what happens in the overall economy, these companies will still be making money… and paying shareholders their cut.
Current Yield stocks pay a little more. These companies could be more likely to cut their dividends. Some of these companies have a variable dividend policy. That means we’ll surely see a dividend cut if the economy slows and profits fall.
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Current Yield stocks are those you want to closely watch for signs of an unexpected cut, especially if you have a short time horizon. If you’re more risk adverse, you need to be very selective about these holdings.
Dividends are always at the mercy of the Board of Directors. They know cutting a dividend signals financial distress and lack of confidence in the business. Generally, they will avoid it as long as possible.
Although I’m not worried, I’ll be watching for warning signs as we enter the Q2 earnings season. I can bet that every earnings call will include mentions of a potential recession and the tariffs.
Make sure to be on the lookout for management teams using either as an excuse for subpar performance. You’re also looking for companies with a plan to deal with either. This was one of the red flags we saw during COVID…and I don’t think now will be any different.
For more income, now and in the future,
Kelly Green
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