I believe that bear market times could be a great time to start building a great passive income stream.
Why bear markets are a good time to build passive income streams
Bear markets are the most painful times when it comes to the share market.
Share prices decline painfully. Profit disappears. Confidence falls. Even dividends are cut, though the cut is usually less affected than the profit drop. This is to Boards having discretion about what dividend payments will be.
However, I think it’s important to remember when share prices fall it causes the dividend yield to increase for potential passive income investors (assuming the dividend isn’t cut).
I’ll give you an example. If a reliable dividend share starts with a 4% dividend yield and the share price drops 33% then the new yield for potential investors is 6%. This is the type of dividend opportunity I’m seeing with shares like Brickworks Limited (ASX: BKW) and Duxton Water Ltd (ASX: D2O).
What about the ones with coronavirus-affected or cyclical dividends?
There are plenty of shares on the ASX that are likely to see dividend cuts over the next 12 months because of the direct coronavirus effects (like travel bans) or the indirect economic consequences.
I think we may see painful dividend cuts from companies like Commonwealth Bank of Australia (ASX: CBA), Macquarie Group Ltd (ASX: MQG), Premier Investments Limited (ASX: PMV) and Cromwell Group (ASX: CMW).
I believe it’s a yield trap to think that the next 12 months of CBA dividends will be $4.31 per share, equating to a 10% grossed-up dividend yield. It could actually be 8% with a 20% dividend cut. It may be 5% with a 50% dividend cut. Not great for short-term passive income.
But, in my opinion, CBA could be the first ASX bank to recover back to its former dividend level in perhaps three years from now. It could be back to paying $4 or more per share. If you take the longer-term view, this could be an opportunistic time to buy future dividends for passive income.
However, I’d prefer the financial shares of Macquarie and Challenger Ltd (ASX: CGF) over CBA for their long-term growth prospects.
How much of a difference does it make for passive income?
Well the S&P/ASX 200 Index (ASX: XJO) is currently down around 25% since the declines began after 21 February 2020. Each individual share will have different dividend prospects. But if that share it has fallen by 25% it boosts the dividend yield substantially.
If a yield was 4%, it is boosted to 5.3%. Imagine you invested $100,000 today – you get an extra $1,333 in dividends compared to if you invested a couple of months ago (assuming no dividend cuts).
If a yield was 6% it is boosted to 8%, and so on.
I think this is an opportunistic time to start building up your passive income stream. You can get a much bigger dividend yield, whether it’s now or later. I believe this will mean more dividends hitting your bank account in the coming years.
Where to invest $1,000 right now
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Motley Fool contributor Tristan Harrison owns shares of DUXTON FPO. The Motley Fool Australia owns shares of and has recommended Challenger Limited, Macquarie Group Limited, and Premier Investments Limited. The Motley Fool Australia has recommended Brickworks and DUXTON FPO. 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.
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