How My Retirement Portfolio Will Profit From The Next Recession

by: Dividend Sensei

We live in scary times for the US economy and the stock market. Many worry that a recession and bear market could be coming next year.

Long-term investing success is about sticking to good core principles while managing risks, so you can profit over the long term from whatever the market does in the short term.

Studies show that time in the market is far more effective than market timing, so a buy-and-hold strategy focused on undervalued quality companies is what I focus on.

I have no plans to sell any of my blue-chip dividend stocks ahead of a recession/bear market. I will use probabilistic macro analysis to stock-pile cash/bonds ahead of likely great buying opportunities.

Right now I'm still buying stocks, though the bond market is signalling it may soon become time to get more defensive. Always focus on good risk management and the proper asset allocation that fits your individual needs/long-term goals.

(Source: imgflip)

I've had a lot of readers ask me about whether today remains a good time to put money to work in blue-chip dividend stocks. After all, fears of a recession in 2020 are rising, and market volatility has increased significantly due to the escalating US/China trade war.

As with most things in finance, the answer is "it depends." So here's how I'm managing my retirement portfolio (where I keep 100% of my life savings, currently about $260,000) ahead of a potential future recession, to potentially give you an idea about how to navigate today's uncertain financial waters to hopefully make better long-term investing decisions that maximize the chances of achieving your financial goals.

Time In The Market Matters Far More Than Timing The Market...

Nothing is more important than understanding key investing principles, which is why I frequently remind readers what Peter Lynch, the second greatest investor in history (behind Buffett), said

In this business, if you're good, you're right six times out of ten. You're never going to be right nine times out of ten...All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don’t work out...Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves.” - Peter Lynch (emphasis added)

Investing is always probabilistic because the future is unknowable. Thus the first step to achieving your long-term financial goals is a sound long-term strategy that's most likely to work in the future.

Market history/studies can be a great guide to determining a core strategy that can help compound your income and wealth over time.

The first thing to know is that the stock market is the best wealth compounder ever discovered, with equities being the best-performing asset class in history.

(Source: Morningstar)

What's more, the stock market is positive in 74% of years, with the probability of making money rising the longer you hold equities. Once you get to 15 years the probability (at least based on historical returns back to 1926) rises to 100%.

(Source: MarketWatch)

And since 1872, no 20-year rolling time period has seen investors lose money, not even those who bought at the pre-Great Depression peak of 1929 (after which stocks crashed 90%, the worst decline in US market history).

What this data tells us is that market timing is something to be avoided, because as market history and Peter Lynch point out, "Time is on your side when you own shares of superior companies."

Further evidence comes from JPMorgan Asset Management, the 4th largest asset manager on earth, which found that the average investor achieved a 1.9% CAGR total return over the past 20 years.

That's worse than buying and holding literally every other asset class and even lost to historically low inflation. What caused those abysmal returns? Mostly market timing, with investors becoming greedy after stocks rose to historically high valuations, and then panic-selling after they predictably declined later.

In contrast, a super conservative 40/60 stock/bond portfolio managed to deliver 5% CAGR total returns, 2.5 times what market timing retail investors managed to achieve, and with a lot less volatility (thus helping you sleep well at night).

The 25-year average forward P/E for the S&P 500 is 16.2. For valuation-based bear markets and mild recessions (like the tech bubble crash), the market tends to decline to a forward P/E of about 14. The Financial Crisis saw valuations decline to 10.3, though that was a historical anomaly that investors shouldn't expect to occur frequently.

For context, the December 24th low saw the S&P 500's forward P/E hit 13.7, approximately the valuation level seen at the bottom of regular recessionary bear markets.

Today the market is at a forward P/E of about 16.5, roughly fair value historically speaking (especially factoring in interest rates about half their historical norm).

What about the question of putting money to work as fast as it comes in (dollar cost averaging) vs. lump sum investing (storing up dry powder for corrections)? Well, Vanguard has an answer for that.

Looking at historical market data from the US, UK, and Australia, Vanguard found that 60% to 70% of the time the highest probability approach to stronger returns was to immediately put money into the market. Your asset allocation didn't matter, whether you were 100% in stocks, 100% in bonds, or somewhere in between.

What does all this data (and advice from Peter Lynch) tell us? That putting your discretionary savings to work in income-producing assets (like stocks) and then holding for the long term is the highest probability way of growing your income and wealth over time.

However, as I said earlier, finance is complicated and there are no absolutes. There are indeed times when it's appropriate to store up dry powder ahead of better buying opportunities to come.

...But We Shouldn't Ignore Risks Either

First off, valuations always matter. Dollar-cost averaging (being fully invested all the time) usually works better than saving up cash to deploy during a correction (which since 1950 have occurred on average every 1.9 years). But not always, such as when market valuations are at historical extremes.

(Source: Ben Carlson, Vanguard)

Here's what Vanguard's lump sum vs. DCA study found when the famous Robert Shiller cyclically adjusted price-to-earnings or CAPE was above 32. When stocks were that overvalued than the probabilities flipped and lump sum (dry powder/correction) investing became the higher probability strategy.

Today the CAPE stands at 30.3. Which is historically high but that will come down significantly in the next 18 months as the Great Recession's low earnings roll off that 10-year average and inflation-adjusted PE ratio (thus no crash is necessarily likely).

Okay, but what about the specific macro risks we're facing now, such as the escalating US/China trade war?

On May 10th, 2019, the effective US tariff rate rose to 6%, almost quadruple what it was 18 months ago, due to the US imposing 25% tariffs on $200 billion in Chinese exports (over 5,700 different goods). If the final $300 billion round of Chinese tariffs (also 25%) go into effect the US will be imposing over 10% tariffs on all its imports.

Goods Final Chinese Tariffs Would Affect

(Source: National Retail Federation)

The final round of tariffs (which could go into effect August or September 2019 after a 90-day comment period) would hit US consumers especially hard since up until now most tariffs have been on intermediate goods, not consumer-facing ones.

Those final 25% Chinese tariffs would cost the average US family of four between $767 and $2,294 per year for as long as they remain in effect. That equates to a 1.3% to 3.9% decrease in annual household income, given that the US Census Bureau estimates median US household income is $59,000.

But 25% tariffs on all Chinese imports is the worst-case scenario. As Moody's Analytics recently pointed out in its weekly research note,

Widespread expectations remain strong that the U.S. and China will come to terms in the next few weeks...This is our most likely scenario as well. Given the difficult progress in the discussions up to now, the costs to the economy and stock market if the war drags on, and Trump’s innate desire to deal, odds are good that some type of arrangement will be struck by the end of the grace period in mid-June. We attach a 60% probability to this baseline scenario." - Moody's Analystics (emphasis added)

Moody's baseline estimate also takes into account America's other trade risks, and what effects that would likely have on the US economy.

The trade deal Trump struck with Canada and Mexico late last year has yet to make its way through Congress, and likely won’t. The baseline thus assumes that the previous NAFTA rules will continue to apply and that the president will not follow through with his threats to renege on NAFTA altogether or—even more serious—to increase tariffs on vehicle imports from Canada and Mexico, where the industry is important. Under these baseline assumptions, the economic outlook will not change meaningfully. U.S. real GDP growth is expected to come in at 2.5% in 2019 and unemployment is expected to slowly but steadily decline throughout the year. Chinese growth is also not impacted, with real GDP growth of 6.3%, and the global economy continues to grow at close to its 3% potential." - Moody's Analytics (emphasis added)

So if Moody's high probability outlook comes true (which I also expect), then the US economy should be fine and no recession/bear market becomes likely.

However, good investing requires keeping less probable (long-tail) risks in mind as well, which is why Moody's also has two alternate and less rosy scenarios it models.

An alternative scenario is that Trump can’t find a way to shake hands with President Xi, and the higher 25% tariffs remain in place for longer, say through the end of the year...The higher tariffs will have a meaningful impact on the U.S., Chinese and global economies. Global businesses can navigate around the impact of a 10% tariff...but navigating around a 25% tariff will prove impossible. Global supply chains will be disrupted, hurting business investment and manufacturing output. This alternative scenario has a 30% probability, and would reduce U.S. real GDP growth this year by nearly half a percentage point to closer to 2%." - Moody's Analytics (emphasis added)

There's also the least probable worst-case scenario that many bears are focused on. Here's Moody's estimate on that grim outcome.

A much more serious, worst-case, and increasingly plausible scenario is that Trump engages in an all out trade war, following through on most of what he has threatened to do. This includes putting a 25% tariff on all Chinese imports to the U.S., which comes to some $520 billion for the past year, about one-fifth of all imports into the country. In this dark scenario, Trump also goes all-in on the 25% tariffs on vehicle imports and parts (from Europe)...The probability of this full-blown trade war scenario is 10%, and is the recipe for a U.S., Chinese and global recession later this year. The Federal Reserve will attempt to cushion the economic blow by cutting rates, and the Chinese will pump up monetary and fiscal stimulus, but these efforts will fall short. The length and depth of the downturn will depend on how long it takes Trump to call a truce, but given the fast approaching presidential election, it is difficult to imagine he would allow the war to continue much into next year. - Moody's Analytics (emphasis added)

In the event of the worst-case scenario (10% probability estimate) Moody's estimates that US GDP could be impacted by 2.6% through the end of 2020. That equates to approximately a 1.8% decrease in annual GDP, potentially causing zero or slightly negative growth next year (and 3 million job losses resulting in roughly zero net job creation).

(Source: New York Federal Reserve)

In Q2, the New York Fed's real-time economic growth model (based on leading economic indicator reports) is estimating 2.2% economic growth. That's roughly in line with the Cleveland Fed's economic model which expects about 2.2% to 2.3% GDP growth this year.

(Source: Cleveland Federal Reserve)

And that's also close to what the Fed expect from this year, with growth in 2020 and 2021 slowing to just under 2%.

(Source: Federal Open Market Committee)

So the bad news is that in the worst case, the trade war could potentially put the US into a mild recession (ala 2001, when peak GDP declined by 0.9% due to the tech bubble bursting).

The good news is that Moody's is confident that won't happen (as am I). But such probabilities are only rough guesstimates, and can always be proven wrong (Goldman Sachs (NYSE:GS) estimated just a 40% probability May 10th's tariff hike would occur but it did).

So when it comes to predicting important economic outcomes like the trade deal, there is one valuable source I turn to, the so-called "smart money" in the world of finance; the bond market. The bond market is far larger and more liquid than the stock market and dominated by institutions (like pension funds, endowments, and sovereign wealth funds) whose job it is to focus on risk and capital preservation first and foremost.

This is likely why the bond market, via the famous yield curve, has managed to predict every recession since 1955 with just one false positive (mid-60s when growth slowed to near zero but never went negative).

There are two specific things I check when considering what the bond market is saying about the economy. The first is the bond futures market, which is where big institutions spend billions to hedge against interest rate shifts.

While the stock market hit a fresh all-time high on May 3rd on expectations that a final trade deal would be announced by May 10th, the bond futures market was signaling a 66% probability of at least 1 rate cut by the Fed in 2019 (with zero chance of a hike).

I interpret that as the bond market correctly predicting that the trade talks would hit a snag and the trade war would escalate (thus potentially hurting the economy enough to require a Fed rate cut). So what is the bond futures market saying now?

(Source: CME Group)

By January 2020 the bond futures market estimates a zero chance of a rate hike, 20% chance that rates will be flat, and a whopping 80% chance that the Fed will have to cut at least once (and over 50% that they will need to be cut more than once). That's a very bearish signal, and one I'm keeping a close eye on.

The second way I track the bond market is with the 10y-3m yield curve itself which an August 2018 study by the San Fran Fed which concluded that "The best summary measure (of recession risk) is the spread between the ten-year and three-month yields.”

That's likely because the Dallas Fed's October 2018 bank loan officer survey found that the 10y-3m curve is closely watched by banks to determine lending policies (specifically when to start tightening credit). In other words, "a moderate and protracted inversion" of the yield curve is seen by banks as a warning that recession is coming and that it's time to reduce credit to riskier borrowers. This reduces the money supply (financial lending accounts for 85% of the US money supply), thus creating the recession they feared was coming.

The yield curve has inverted twice now, once in late March (for 6 straight trading days) and is now flat after spending four straight days negative.

In the next section, I'll discuss the various yield curve/recession confirmation criteria (there are four major ones) but one big one is 10 consecutive days of inversion (by any amount).

(Sources: Bianco Research, MarketWatch)

Since 1969 (the last 7 recessions) anytime the curve has stayed negative for 10 consecutive trading days a recession has always followed, on average within 10.5 months. While seven data points aren't statistically significant enough to say with certainty that such an event guarantees a recession is coming in 2020, it would certainly increase the risks of one, which are already at 10-year highs according to the Cleveland and New York Federal reserves.

(Source: NY Federal Reserve)

The uncertainty surrounding the escalating trade war could easily cause those risks to rise to 35+%, and the peak 12-month recession risk prior to the last three recessions was 35% to 50%.

In other words, the US is possibly sitting on the knife's edge regarding whether or not the longest economic expansion in history (as of July 1st, 2019) will continue for several more years or end in 2020. The trade war could prove to be the catalyst that pushes us over the edge into recession.

And while historical data can only tell us roughly what's likely to happen (never what will certainly happen) the fact is that since 1946 no recession has ever not resulted in a bear market, which on average sees stocks decline 13% more than non-recessionary ones.

Which brings me to what I'll be doing with my retirement portfolio, where I keep 100% of my life savings. How do I balance the overwhelming data that supports buy and hold and dollar cost average investing with the growing risk that we could be facing a major stock market slide (where far better deals will be bountiful)? Via a hybrid strategy that incorporates all the things I've learned over my five years as a professional analyst/investment writer.

My Retirement Portfolio Plan For The Next Recession

Since the core of my investing strategy is focused on maximizing safe and growing dividend income, I have two very simple rules about selling.

  • Never sell stocks just because you think they could fall in the short term
  • Only sell stocks if the thesis breaks (dividend is no longer safe or likely to grow) or possibly if they become obscenely overpriced (50% or more).

Remember all investing is probabilistic and the goal of all successful investors is to maximize the probability that their money and passive income will compound over time.

(Source: Ploutos Research)

Given that stocks overwhelmingly spend most of their time rising, including blue-chips like the famous dividend aristocrats (S&P 500 companies with 25+ consecutive years of dividend growth, which historically outperform the market with much lower volatility), my 100% blue-chip dividend focus and strong fundamental portfolio stats say that not selling except on very rare occasions, is the highest probability strategy.

  • Total Portfolio Annual Dividends: $13,970
  • Portfolio yield on cost: 5.2%
  • 1 Year organic dividend growth (purely from payout hikes): 16.7%
  • 5-year average organic dividend growth: 13.6% CAGR
  • 10-year average organic dividend growth: 10.9% CAGR
  • Forward 5-year analyst consensus dividend growth (courtesy of Morningstar): 6.7% (possibly due to recession expectations)

My goal is to eventually be able to retire on 50% of post-tax dividends alone. That will give me the financial freedom to work only at what I love (this job) and only as much as I want (four days per week, not six).

The portfolio is now 100% blue-chip (or higher) quality companies (based on my 11-point quality score that factors in dividend safety, business model and management quality). Thus I have high confidence that even in a recession my dividend income will keep rising (though slower).

(Source: Simply Safe Dividends)

That confidence is based on the fact that even during the worst economy since the Great Depression my portfolio's organic dividend income (no dividend reinvestment) would have

  • grown 18% in 2008
  • grown 5% in 2009
  • grown 14% in 2010

For context, the S&P 500's median dividend growth rate over the past 20 years (and thus a good estimate of long-term market dividend growth) was 6.6%.

Since 1954 a good way of estimating future total returns has been the Gordon Dividend Growth Model, which Brookfield Asset Management (BAM) has used for decades as the core of its return estimate model. This simply says that total returns over time = yield (current income) + long-term earnings/cash flow growth (which dividends track assuming constant payout ratio). Long-term cash flow growth is basically an estimate of capital gains since valuation multiples tend to mean revert over time.

To this model, I add a valuation-adjustment since if you buy a stock at historically low valuations then a return to historical multiples will result in shares outpacing earnings/dividend growth over time. Historically this valuation-adjusted total return model is accurate to within 20% (margin of error) over time periods of 5+ years (when sentiment washes out and only fundamentals matter).

Total return = yield + long-term earnings/cash flow growth + valuation boost (return to fair value over 5 to 10 years)

  • Portfolio yield: 5.3%
  • Analyst forward earnings growth consensus: 6.7%
  • Expected total returns assuming no valuation changes: 12.0% (vs market's historical 9.1%)
  • Valuation: 15% discount to fair value (Morningstar's DCF estimates)
  • 5 to 10 year expected valuation boost: 1.7 to 3.4% CAGR
  • Valuation-Adjusted Total Return Potential: 13.7% to 15.4%
  • Margin of error adjusted expected total returns: 11.0% to 18.5%

This is why my entire recession plan is based on what I do with new money, not savings I've already invested. After all, when you own nothing but quality companies, purchased for about 15% discount to fair value (using a highly conservative valuation estimate) and are likely to enjoy long-term total returns that are 11+% (roughly three times what asset managers expect the S&P 500 to deliver over the coming five to 10 years) time is only on your side.

Success comes down to sitting patiently and letting your companies do all the heavy lifting, while you watch safe and exponentially growing dividends roll in (almost $40 per day on average).

Ok, so that answers why I'm not going to sell what I own, no matter how high recession risk gets (since market data, historical studies, and Peter Lynch say not to) but what do I intend to do with my new money which arrives every single week.

First, as I've already explained my default strategy is to buy undervalued dividend blue-chips (off a 166 company watchlist) with the goal of maximizing my long-term income, while eventually getting to my risk management rules.

Given my personal situation ($1,000 per month average expenses, a VA disability pension of $1,800 per month, and $14,000 per month total income from 32 sources) I have no need to own bonds or cash. So during normal economic conditions (no recession is likely soon), I am 100% in stocks.

I'm working on diversification at the moment, with energy and REITs currently 22% and 21% of my portfolio. I currently own 27 companies with six of them being above my preferred 5% holding size (so can't buy those for now).

I like to use limits to ensure I'm getting a great value for my money.

Current Retirement Portfolio Limits Open

Company Ticker Limit Price Yield At Limit 5-Year Average Yield Estimated Discount To Fair Value (Dividend Yield Theory) Morningstar's Estimated Discount To Fair Value (NYSE:DCF) Estimated Discount To Fair Value (Average of DYT and Morningstar) Expected Total Return (CAGR Next 5 Years)
A.O. Smith (AOS) $39.99 2.2% 1.1% 50% 15% 33% 18%
British American Tobacco (BTI) $36.72 7.3% 4.0% 45% 38% 42% 24.5%

(Sources: Simply Safe Dividends, Morningstar, Gordon Dividend Growth Model, Dividend Yield Theory, F.A.S.T Graphs)

British American I recently added to diversify my holdings, sectors and lock in a safe and growing (at 4% for three years then 7% to 9% per year long-term) dividend.

A.O. Smith, I bought on May 16th on the day of the short-attack crash (speculative claims about possible accounting fraud and Chinese sales falling off a cliff).

I love to be opportunistic on aristocrats, especially when the market freaks out and drives them down 10+% in a single day. This is why I've bought Walgreens (WBA), 3M (MMM) and now A.O. Smith in 2019, on just such crashes.

Historically such crashes are not thesis breaking events, but great long-term buying opportunities.

Dividend Aristocrats 12-Month Forward Returns Following 10+% Single Day Crash

(Source: Ploutos Research)

Over the past 10 years, 18 aristocrats have declined at least 10% or more in a single day. 80% of the time they have bounced back within 12 months, with an average gain of 32% and a median gain of 33%.

While such data isn't a guarantee of huge gains over the next 12 months, it certainly supports opportunistic buying of the bluest of blue-chip dividend stocks. Remember my time frame is 5+ years (because some of Lynch's biggest winners took up to 4 years to break even).

Buying AOS at $43.71 and then setting a follow on limit at a truly absurd price, would allow me to add a position in a great company up to about 4% of my portfolio.

British Tobacco is the most likely limit to trigger (my last one of the month) and represents one of the highest low-risk total return opportunities I know of right now (potentially 25% over the next five years).

But what if recession risk rises and an economic downturn and bear market then becomes likely within the next year? Well during bear markets even highly undervalued blue-chips can fall (just 3 aristocrats/kings managed to deliver 0+% total returns during the Great Recession).

That's where my probabilistic macro analysis comes in. There are several different major recession confirmation periods analysts use with the 10y-3m yield curve inversion.

Thus far none of these four confirmations have occurred. What's more, the actual economic data, based on 19 leading economic indicators, now point to growth accelerating from its recent low levels (leading indicator average, the green dot is once more showing expansion and where the mean of coordinates is likely to go over the coming weeks)

(Source: David Rice)

This means that the trade war remains merely a risk (something that might hurt fundamentals) but the economic fundamentals themselves remain solid.

This is why I continue to buy opportunistically. However, should two yield curve confirmations trigger, then I'll turn off my limits and begin stockpiling liquidity via my incoming weekly savings.

  • 10 consecutive days inverted: turn off limits, start buying the PIMCO Enhanced Short Maturity Active ETF (MINT) - 2.5% yielding monthly paying ultra-short-term bond ETF (cash equivalent)
  • 1-month inversion confirmation: switch weekly savings to buying Vanguard Long-Term Treasury ETF (VGLT) - 2.7% yielding, very long-term US Treasury ETF (hedge during bear market)

The logic behind buying MINT is that should the yield curve rise and fall above zero (signaling bond market is uncertain about recession probability) then owning that super stable asset, which trades flat as a pancake as you expect from a cash equivalent, can be used to buy stocks opportunistically as long as a recession remains unlikely.

VGLT is useful as a hedge during a recession because its long duration (18) means that each 1% decline in long-term rates (10-year yields) results in about 18% capital appreciation. This means that during a bear market VGLT would likely appreciate even more than 10-year treasuries, which have done extremely well during previous recessions.

I don't plan to switch between MINT and VGLT once they are purchased. Both are likely to remain stable or appreciate during a market panic (flight to safety and falling interest rates) which means that when a bear market finally becomes official (S&P 500 closes at -20% from ATH) I'll have stored up tens of thousands worth of assets I can sell at a slight to modest profit to buy blue-chip dividends stocks trading at truly absurd valuations.

Things To Keep In Mind

(Source: imgflip)

There are three things to remember about my retirement portfolio's recession strategy. First, it's designed as a holistic long-term strategy that allows me to profit from whatever the market is doing.

If the economy is growing I'm buying undervalued blue-chips opportunistically, always working towards advancing my portfolio's goals (maximizing long-term safe income while working on long-term diversification targets).

If the economy appears in trouble (per the bond market and leading economic indicators) then I'm still growing my income (via buying bond ETFs) and preparing for even better buying opportunities in the future.

Note what I'm not doing. I'm not trying to time the sale of what I already own (over $260K worth of quality companies) based on the potential of a recession. Even if the yield curve were to invert for a consecutive quarter that doesn't guarantee that a bear market is coming soon.

That's where balancing risk and future opportunity with a high probability strategy (remember stocks are the best asset to own long term) comes in. As the above quote from Peter Lynch points out, short-term stock prices are a distraction.

Always focus on the long-term fundamentals. As long as a company is well run (and a good business) then cash flow and dividends will grow over time. Stock prices are ultimately a function of cash flow. The market can remain irrational for a long time (I've seen entire industries trade flat for as much as six years).

But eventually rising cash flow and dividends always cause the stock to approach fair value (and often overshoot it). Industries and companies go in and out of favor over time, that's the nature of the market, and what contrarian value income investors like me count on.

As long as you have a well-constructed portfolio (diversified with proper asset allocation for your needs) then the value of your portfolio literally doesn't matter at all from day to day, or even year to year.

Stocks in a multi-year bear market and you're retired and need to sell assets to pay the bills (like retirees on the 4% rule)? That's why you need to own enough cash equivalents and bonds. Those will likely remain stable or appreciate in a market crash.

This is because in the modern era (of low inflation and low interest rates) bonds tend to be inversely correlated to stocks. The 4% rule doesn't say to blindly sell 4% of everything in your portfolio in equal proportion.

Stable cash is what you sell first. When that's gone you sell appreciating bonds. Dividends from stocks (plus interest from bonds) help maximize the time you can avoid selling quality stocks at historically undervalued levels.

If you construct your portfolio correctly then you can take a zen-like approach to investing, which is what both Buffett and Lynch say is the true secret to long-term investing success.

You must approach investing with a Vulcan like dispassion (forgoing emotion in favor of logic), and seek contentment, not joy or euphoria. That's what I strive to do, through training myself to ignore the market's wild and typically irrational swings.

The market is rising? I'm content because something great is always on sale so I can steadily buy; meanwhile, my safe and exponentially growing dividends are rolling in.

The market is falling? I'm content because I get to buy great companies at even more insane discounts to fair value (locking in higher yields on cost and better long-term returns). Meanwhile, my safe and exponentially growing dividends are rolling in.

Market trading flat? I'm content because I keep steadily buying opportunistically (dividend aristocrats will always occasionally be crashing 10+% in a day) and my safe and exponentially growing dividends are rolling in.

Note the common theme here? Safe and growing dividends are the core focus I have. Literally, the entire reason for my retirement portfolio is this chart.

Retirement Portfolio Annual Dividends

(Source: Simply Safe Dividends)

Four months of the year my dividends almost match my VA pension. On Wednesday, May 15th, I received almost $800 in dividends. The Wednesday before that $500. On June 1st I'm getting almost $400 from Enbridge (NYSE:ENB).

I work very hard for my money, and sometimes make $650 in a day but that takes 12 hours and writing three articles. To get paid a similar amount (and more every single year), even if I were to take a day off? Well, that's my idea of the American dream.

My goal is to treat my portfolio into a business (a holding company with partial stakes in other companies). Thus I have a long-term mentality which doesn't care about short-term capital gains, but long-term income.

Quality first, valuation second, and then it becomes just a matter of time until you succeed.

As for my specific recession protocol for new savings? Are those perfect? Almost certainly not. But I don't need to have the exact formula figured out for when to stockpile cash and when to put it to use. As Lynch said, you only have to be right 60% of the time, and then let your winners run and make you rich.

Risk management via diversification and asset allocation, not market timing, is how you protect yourself during inevitable but unpredictable recessions and bear markets.

Finally, I need to point out that my 100% stock allocation (which will likely always be above 80% or higher) is merely right for me. The asset allocation that's right for you will be different since you likely have neither my time horizon (I'm 32 and have 50+ years to let this strategy play out) nor my high savings (about $10,000 per month I can invest).

Here's a useful table for estimating what mix of stocks/bonds (cash equivalents are like bonds) you should have. 40% to 60% in bonds is what most financial advisors recommend as a rule of thumb, due to studies the 4% rule is based on (William Bengen's famous 1994 paper).

Consult a fiduciary financial advisor if you want to get highly specific or pick an allocation that offers the right mix of long-term historical return, and a worst year decline that won't cause you to lose sleep at night.

Bottom Line: Good Investing Requires Balancing Risk/Opportunity And Having A Reasonable Plan That Fits Your Personal Financial Goals

When it comes to the question of how much dry powder to hold I tend to lean towards the dollar-cost-averaging crowd. Decades of market studies (by Vanguard and others) show that time in the market matters far more than timing the market (which very few can do well). This is why I consider a bird in the hand (great undervalued blue-chip on sale today) to be worth more than two birds in the bush (possibility of buying that blue-chip at an even greater discount during a possible bear market).

Thus as long as recession remains unlikely I'm happy to be putting my money to work opportunistically into undervalued blue-chips, each purchase advancing my overall portfolio goals of an ever more diversified stream of safe and exponentially growing passive income.

But I'm also not blind to the risks of a future correction and bear market (both are inevitable). This is why I'm willing to take a page from Buffett's book (about 30% cash position over the last few years) and stockpile dry powder for future bargain opportunities if a recession becomes a high probability event.

That's where my cash equivalent and bond ETFs (MINT and VGLT, respectively) come in. Right now I don't own any, but should the macroeconomic outlook turn sufficiently negative, I will.

But note that I will not sell a quality dividend stock unless it becomes obscenely overvalued or the thesis breaks. I buy my companies purely for safe and growing dividends.

As long as they continue to deliver those then I'm content to let the market river wash over my portfolio and opportunistically grab the best opportunities it brings my way.

Ultimately, smart investors can disagree about the specific nuances of capital allocation (precisely how much you buy, of what, and when). But the time tested core strategies of Buffett, Lynch, Graham, Dodd (and many other legendary investors) remain the same:

  • Quality companies
  • At good to great prices (fair value or better)
  • hold for years or decades

My two favorite Buffett quotes of all time summarize the true secret to investing successfully

We don't have to be smarter than the rest. We have to be more disciplined than the rest."

"The stock market is designed to transfer money from the active to the patient."

Disclosure: I am/we are long AOS, BTI, MMM, WBA. 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.