Volatility Is Back. Dividend Growth Stocks Can Help

|
Includes: JNJ, MO, PG, XOM
by: Doug Carey
Summary

Volatility surged 40% in one day last week.

To protect yourself against major downturns for the long run, look to stable dividend-growth stocks.

We run a Monte Carlo analysis to show how dividend growth stocks can help lessen the impact of volatility.

Volatility up 40% in one day! All because the Fed mentioned that they might raise rates, perhaps sometime soon? Yes, that is the new normal in our crazy world of investing today.

The most followed measure of market implied volatility (VIX) moved up 40% on September 9th. Pretty much every market dropped substantially on this day as well. The S&P 500 (NYSEARCA:SPY) was down 2.4% and the Nasdaq (NASDAQ:QQQ) was down 2.6%

Which Stocks Were Not As Volatile?

I have discussed before how many dividend growth stocks are by their nature less volatile than the overall market. A few of my favorite dividend growth stocks to weather volatility today are Johnson & Johnson (NYSE:JNJ), Exxon (NYSE:XOM), Altria (NYSE:MO), and Procter & Gamble (NYSE:PG).

The best place for a longer-term look at how solid dividend payers performed during volatile times is the last recession. Let's take a look at how the four stocks cited above did during the last major market downturn:

Price Change January 2008-December 2008

S&P 500

-32.7%

Altria

-2.8%

Johnson & Johnson

-2.5%

Exxon

-5.0%

Procter & Gamble

-5.5%

Many Dividend Growth Stocks Should Be Less Volatile

Why should the best dividend payers be less volatile? It's all in the math of their total returns. Their stable dividend payments mean a less volatile rate of return over time. Also, many of the most consistent dividend payers are consumer staple stocks and are generally less cyclical than other companies.

In this article, the author shows that dividend growth stocks have volatility levels that have historically been about 33% lower than non-dividend paying stocks. It should not be too surprising because, as I mentioned already, dividend payouts are more stable than stock prices. Because the future dividend payout contributes to the future rate of return, the return and price overall price volatility should be less for these types of dividend payers.

Protection For Your Retirement Portfolio

I wanted to take a look at how the four stocks I mentioned can make your retirement portfolio less subject to the ups and downs of the overall market. I looked at two different retirement portfolios in the WealthTrace Financial & Retirement Planner, which is available to the public. The types of calculations I did for this are not available in your typical free retirement planning tools.

My first portfolio invests in 80% stocks and 20% bonds. All of the stocks are invested in an S&P 500 index fund. The volatility (standard deviation) for the S&P 500 has been about 17% over the last decade. I ran this retirement plan for a 47-year-old couple with $350,000 in investment assets and annual retirement expenses of $60,000. It doesn't look good for them. A Monte Carlo analysis tell us that their probability of never running out of money is only 43%.

But if we replaced their S&P 500 holdings with a basket of solid dividend payers? That is just what I did. My results for this are below:

Even I was surprised at the large jump here. But the direction of the change was no surprise. The consistent income payments made by these dividend payers helps smooth out fluctuations in stock prices. If held long enough, the principal value of many dividend growth stocks becomes nearly meaningless. Why? Because their dividends become the majority portion of the total returns, compounded over time. So, the volatility of stocks during tough times does not impact investors nearly as much, either monetarily or psychologically.

Monte Carlo analysis is a great tool for teasing out scenarios like the one I ran here today. It's just further proof that solid dividend growth stocks with a long history of increasing dividends can set you up for a less stressful retirement.

Disclosure: I am/we are long XOM, JNJ, PG, MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.