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Summary

  • Do you believe a pullback is due? If so, what's your strategy to cushion yourself during a market sell-off?
  • Jeremy Siegel called dividends "bear market protectors" and "return accelerators."
  • A market pullback is perhaps the best time to reinvest dividends in the paying company.

Another week filled with predictions about a market correction, if not a crash. To add fuel to the fire, the market had its worst week in two months. Where do all these leave common investors like most of us on Seeking Alpha? This article presents a few reasons I am not worried about a crash and why in fact I might love one. Let us get into the details.

Right off the bat, for the randomness and black-swan fans out there, no one can predict a World War or an accounting scandal. Hence, this article will ignore the occurrence of those events, because planning only for such 1% events will likely leave us without a plan for the 99%. One can try building a portfolio of bonds, stocks, cash, and real estate to reduce the impact of such black swan events, but that discussion is for another day. This article is strictly about a stock market decline/correction/crash.

Stocks discussed: AT&T (NYSE:T), Coca-Cola (NYSE:KO), Philip Morris (NYSE:PM), Altria Group (NYSE:MO), Realty Income Corporation (NYSE:O), Lorillard (NYSE:LO), Southern Company (NYSE:SO), Omega Healthcare Investors (NYSE:OHI), McDonald's Corporation (NYSE:MCD), Chevron Corporation (NYSE:CVX), and GlaxoSmithKline (NYSE:GSK).

Dividends and Dividend Increases: Let us get the obvious out of the way. Dividends cushion an investor's portfolio during good times and bad. When the market is rolling up, it is hard to notice the impact of dividends, as capital gains likely overshadow the quarterly payments. However, during a market sell-off, dividends pad up the portfolio from the "paper" capital losses.

Whatever happens to the so-called market:

  • I am fairly sure the stocks I own will keep increasing their dividends each year. Now, the dividend growth rate might be a bit less than normal, but an increase is still an increase.
  • Coca-Cola will announce a dividend increase in February of 2015, 2016 and each year, no matter where the market is. You might call that "following the past" but as Patrick Henry put it, "I have but one lamp by which my feet are guided, and that is the lamp of experience."
  • Realty Income, with 98% tenant occupancy, will still be the "monthly dividend" company compounding my money even faster.
  • GlaxoSmithKline and Omega Health Investors will continue making money as the number of elderly keep rising due to the baby boomers in the U.S. and in other developed parts of the world, like Europe and Japan.
  • Southern Company will still be serving millions with power.

More Shares: As someone investing for the very long term, I am reinvesting all my dividends [DRIP]. On the surface, it might sound like being lazy for not re-deploying that money effectively elsewhere, but dollar cost averaging has its merits over the long run. When the market is down, your reinvested dividends get you more shares.

For example, let us assume you own 1,000 shares of AT&T and you are reinvesting your dividends at the current price of $35/share. 1000 shares net you $1,840 in dividends at current rate, and that means each year you accumulate 52 new shares ($1,840 dividend by $35). Let us say the market goes to the dogs, and AT&T is trading at $25. The number of shares you start with will remain at 1,000 and your annual dividend will remain at $1,840. However, the number of shares purchased/yr due to DRIP will increase to almost 74 from 52. This means you collect even more dividends for your dividends.

I still would love it, only cheaper: As someone who believes in putting in all the hard work before initiating a position in the stock, I would love to buy more of the same stocks if they were cheaper. As an example, if I loved buying Chevron at the 3.50% yield for its long-term fundamentals, it is highly likely that I would buy it at the 4.50% or 5% yield point. In other words, new capital can be deployed at a cheaper price during market sell-offs.

Will these companies be affected by an economic downturn? Sure, but the impact on these companies will be much less than on discretionary stocks like Ford Motor (NYSE:F) for example. In addition, companies like Philip Morris, McDonald's and even Lorillard (3rd biggest tobacco maker in market share) have the pricing power to offset decline in volume. While that might sound self-defeating, all these companies have repeat customers and a majority of them are unlikely to go away just because the market is selling off.

Liftoff: Jeremy Siegel called dividends "bear market protectors and return accelerators." We've seen in the sections above how dividends can be bear market protectors by cushioning your portfolio with more money/more shares. The forgotten piece is how dividends will help the returns rocket higher when the market eventually turns up.

Remember the AT&T example. The 22 extra shares accumulated during the market meltdown would propel your returns higher. Plus, when things recover, most investors will look at buying bargains in quality stocks. Detractors of "safe stocks" would like to point out that not even Altria Group was safe from the onslaught in 2009. But what they do not realize is once the market turned up, quality stocks got bid up real quick, as can be seen in the chart below.

If this does not look impressive enough, please keep in mind the extra shares accumulated with DRIP and the fact that those shares will run up higher, while also producing more in dividends.

(Altria: click to enlarge)

(Source: Yahoo Finance)

Unexpected Opportunities: This section is a bit vague and generic, as I have no specific examples to write about. But the point is that a panic-driven sell-off might present opportunities that you've never even imagined in your dreams. Maybe AT&T yielding 7% to 8%? I would love it.

Conclusion: So, what is your game plan if a sell-off occurs? Will you see that as an opportunity to establish your dream positions or will you be part of the group that sells off? Please leave your comments below.

Source: Market Crash?: Why I Would Love One