This year the market has been quite volatile, with significant run ups followed by steep declines. This has provided income investors first hand experience in managing both their emotions and their income portfolio in an unsettled market.
For some new investors, this may be their first opportunity to experience a significant downturn. To make the most of these trying times, here are some concepts to help you succeed and thrive during a market correction:
I. Remember Why We Are Income Investors
The goals of an income portfolio are different than those of a capital appreciation based portfolio. The good news is an income portfolio consisting of dividend growth stocks can not only succeed, but excel during a down market.
An investor in dividend growth stocks is seeking to build a steady stream of rising income from solid companies. While everyone else is panicked about their portfolio's decline, income investors see the downturn as an incredible buying opportunity.
II. When The Chips Are Down, Go For The Bluest Ones
If a market correction makes you feel dark and gloomy, remember one of the true bright spots of a down market is the ability to strategically pick up some bargains in the bluest of blue chip stocks. Normally, these stocks are difficult to buy due to a built in "safety" premium for times like these.
During turbulent times, over-allocate to safe stocks and save the risker investments for another day. Here are some traditional dividend stocks that have a Risk Rating of 1.50 or lower currently trading at a discount:
Yield: 2.5% | Risk Rating: 1.50 | Discount: 21.3%
Lowe's Companies, Inc. sells retail building materials and supplies, lumber, hardware and appliances through more than 1,700 stores in the U.S. and Canada.
Yield: 2.5% | Risk Rating: 1.50 | Discount: 21.0%
Wal-Mart Stores, Inc. is the largest retailer in North America. Wal-Mart operates a chain of discount department stores, wholesale clubs, and combination discount stores and supermarkets.
Yield: 2.6% | Risk Rating: 1.25 | Discount: 7.4%
Colgate-Palmolive Company (Colgate) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
McDonald's Corporation (MCD)
Yield: 2.7% | Risk Rating: 1.25 | Discount: 5.7%
McDonald's Corporation is the largest fast-food restaurant company in the world, with about 32,900 restaurants in 117 countries.
AFLAC Incorporated (AFL)
Yield: 2.7% | Risk Rating: 1.50 | Discount: 21.5%
Aflac Incorporated provides supplemental health and life insurance in the U.S. and Japan. Products are marketed at work sites and help fill gaps in primary insurance coverage. Approximately 80% of earnings comes from Japan and 20% from the U.S.
Medtronic Inc. (MDT)
Yield: 2.8% | Risk Rating: 1.00 | Discount: 0.7%
Medtronic Inc.is a global medical device manufacturer with leadership positions in the pacemaker, defibrillator, orthopedic, diabetes management, and other medical markets.
General Dynamics (GD)
Yield: 2.9% | Risk Rating: 1.25 | Discount: 3.2%
General Dynamics is the world's fifth largest military contractor and also one of the world's biggest makers of corporate jets.
Pepsico, Inc. (PEP)
Yield: 3.3% | Risk Rating: 1.25 | Discount: 0.2%
PepsiCo, Inc. is a major international producer of branded beverage and snack food products.
Abbott Laboratories (ABT)
Yield: 3.5% | Risk Rating: 1.50 | Discount: 21.8%
Abbott Laboratories is a diversified life science company and is a leading maker of drugs, nutritional products, diabetes monitoring devices, and diagnostics.
The Clorox Company (CLX)
Yield: 3.7% | Risk Rating: 1.25 | Discount: 9.9%
The Clorox Company is a diversified producer of household cleaning, grocery and specialty food products and is also a leading producer of natural personal care products.
Nucor Corporation (NUE)
Yield: 3.7% | Risk Rating: 1.50 | Discount: 24.5%
Nucor Corporation is the largest minimill steelmaker in the U.S., and has one of the most diverse product lines of any steelmaker in the Americas.
Avon Products, Inc. (AVP)
Yield: 5.0% | Risk Rating: 1.50 | Discount: 0.3%
Avon Products Inc. is the world's leading direct marketer of cosmetics, toiletries, fashion jewelry and fragrances, with about 6.5 million sales representatives worldwide.
III. Sometimes We Will Misfire
As hard as we may try to pick all winners, sometimes a good stock will go bad, cut its dividend, and we'll have to sell it. Sometimes it is one of our higher yielding stocks, leaving a large void in our annual dividend income. How do we manage this?
Here is what I do:
- First, when you suspect a stock might cut its dividend put it "On the Shelf" and don't make any future purchases, until you are convinced the dividend will not be cut.
- Manage the risk of a dividend cut by limiting your allocation to any single stock to a maximum of 5%.
- Keep some high risk/high yield allocation in reserve. When the market goes south, we need to under-allocate high risk/high yield stocks. This will allow room in our allocation to selectively purchase these types of stocks when we choose to sell a past performer that is no longer meeting our expectations.
As your income portfolio grows, you will not always be able to immediately replace the lost income when you are forced to sale a stock. However, the above principles will help you minimize the decline.
IV. Don't Let Fear Derail Your Long-Term Plan
Someone once said, 'Your emotions are the best inverse indicator of what you should be doing in the market'. Many people are selling it all and walking away from the market. They'll be back though - when the market is reaching all time highs, only to get out when it begins to fall with no end in sight. This is a long-term recipe for disaster.
For those of us who still have time before retirement, down markets present us with a golden opportunity. What will you choose to do with it?
Disclosure: Long WMT, CL, MCD, AFL, MDT, GD, PEP, ABT, CLX, NUE. See a list of all my dividend growth holdings here.