While we can’t ever be certain of the timing regarding market downturns, we do know a downturn’s going to happen sooner or later.
And when it does happen, it’s not going to feel nice. It’ll feel horrible and shares will become the asset nobody wants to own.
If it’s a full blown market crash, it will likely be accompanied by a recession. But large market crashes are actually not that common. More often than a crash, we will go through a ‘correction’ or ‘bear market’ commonly defined as when share prices drop 10% or 20% respectively.
Many companies we’re investing in, will be hit hard in a recession. Profits will take a hit across most businesses. But the upside for income investors is, dividends usually drop much less than share prices.
Management and boards appreciate how important the dividend stream is to many shareholders, so they’re reluctant to cut it too steeply. This goes especially for certain companies that are typically held for their dividends, such as Commonwealth Bank of Australia (ASX: CBA), Wesfarmers Ltd (ASX: WES) and Westpac Banking Corp (ASX: WBC).
By investing in a broad group of companies from different industries, a portfolio will produce a more reliable source of dividends, compared to a portfolio focused on only a handful of names like the banks and Telstra Corporation Ltd (ASX: TLS).
The worst thing an investor can do during a downturn is to sell their shares. Whether they tell themselves they’ll get back in later when things calm down or not, is irrelevant.
They’ve already lost.
There’s no way of knowing when that perfect time will come to get back in. What’s likely is, by the time the investor is comfortable getting back into the market, shares have already recovered most of their losses, or even moved on to new highs.
It simply makes no sense to play this timing game. I can’t do it. You can’t do it. Even Warren Buffett can’t do it.
The point is, we need to do whatever it takes to keep ourselves in the market and ‘stay the course’. For some people (like myself), the comfort of owning shares which pay a healthy and sustainable dividend stream, is what helps them keep their nerve when the market heads south.
Because we know dividends are generally more stable than share prices, in good times and in bad, it gives us something a bit more reliable to focus on.
Regardless of what happens to share prices in a downturn, we know we’ll be receiving at least a decent amount of dividend income on a regular basis. Focusing on the income stream from your investments might just be the behavioural advantage you need to stick to your guns and remain fully invested when the next downturn hits.
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Motley Fool contributor Dave Gow owns shares of Wesfarmers Limited. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.