Dividends are a powerful force in investing at the best of times. They make up a large proportion of overall returns from the stock market. They can also play a key role when it comes to compounding returns (earning a return on past returns) due to the fact they can be reinvested.
In a bear market, however, the benefits of dividends are magnified. Here, I’ll explain why dividends can have a huge impact on investment portfolio returns when share prices are falling.
Return accelerator
One of the main benefits of receiving dividends is that the income can be used to buy more shares. In a bear market, this is a huge advantage as you have the opportunity to buy more shares at lower prices. If you reinvest your dividends while share prices are low, your portfolio is likely to receive a big boost when share prices recover. As finance professor Jeremy Siegel explains: “Reinvesting dividends turns into a ‘return accelerator’ once stock prices turn up.”
Looking at my own dividend portfolio, I’m excited. I’ll be receiving big dividend payments from a number of companies – including oil major Royal Dutch Shell, logistics specialist Tritax Big Box, and tobacco giant Imperial Brands – in the next week or so. I’ll be looking to reinvest this cash in stocks while share prices are low. That means when the market recovers, my portfolio receives an added ‘return accelerator’ boost.
Positive returns
Another big advantage of dividends in bear markets is they support overall portfolio returns. While the returns from share prices may be negative, the returns from dividends will still be positive (assuming you own high-quality, dividend-paying companies that don’t stop paying dividends). This means the dividends will offset the capital losses, supporting overall performance.
It’s also worth noting that, in a bear market, those who rely on dividends for income (i.e. those in retirement) are likely to be much better placed than those who rely on selling shares at regular intervals for cash flow. Those who are receiving a regular stream of dividends don’t need to worry about selling shares at low prices and locking in losses.
Portfolio protection
Finally, stocks that pay reliable dividends can hold up well when share prices are falling. Take consumer goods champion Unilever for example. While the FTSE 100 index has fallen about 30% over the last month, ULVR has fallen less than 10%. That’s a huge outperformance.
Health and hygiene specialist Reckitt Benckiser is another good example. Over the last month, its share price has also fallen less than 10%, meaning it has outperformed the FTSE 100 by a significant margin.
Of course, not every dividend stock has outperformed like this. But many high-quality dividend payers have held up quite well. This means those who own a portfolio of high-quality dividend payers may not have experienced the same kind of losses as those investing in more speculative growth stocks.
Overall, dividends are a very powerful force during bear markets. When share prices are falling, dividends really shine.