How can dividends help investors when markets are volatile?
The question ofhow to invest during volatile markets has been top of mind for many as 2022 has been a challenging year with global marketsin the red. This negative trend has some investors seeking solutions to help manage risk – one of those ideas is investing in companies that pay dividends.
Some investors seek to manage risk by getting out of the market entirely. However, sitting on cash earns very little and creates a bigger question of timing the market. Others prefer to sell their investments and look to products such as Guaranteed Investment Certificates (GIC). While the interest rate has improved on GICs, the problem here is that money is locked in for one year or longer which means that if the markets improve in the meantime, an investor may miss the rally fully. Another option is to focus a portfolio on well known companies that have a long history of paying dividends.
Various companies pay dividends as part of their profits back to shareholders. Simply put, a dividend is like a bonus for owning shares of a company. The dividend is announced well in advance and in many cases, some of these companies have been paying dividends for decades. Better yet, some of these companies have not only paid a dividend for years but they have also increased their dividend, meaning long-term shareholders have experienced higher payouts. In Canada, you can find many well-known stocks that pay dividends between 3% to 5%, or even higher.
Part of this strategy means understanding two key aspects. The first is that when investing for the dividend, one can expect a set payment, or return, over the course of a year. The other is the share price itself and therefore the original investment will rise or fall as markets change. In the case of the dividend, investors generally can proceed with confidence in knowing that they will at least get that rate of return while the share price sorts itself out in time.
How this helps in a volatile market is that investors are “paid to wait”. Said differently, the markets will continue to change, but the dividend will come in regardless. A long-term investor will focus on the dividend and expect that in time they will see the eventual recovery. Incoming regular dividends also act as a great buffer for when share prices are declining.
The truth is that no one knows for sure what happens next to the economy or the markets, and investors are often surprised. If investors are sitting in cash or on the sidelines, one can miss some of the best return periods for investing. Dividend investors get the best of both worlds – a specific rate of return plus the future change in share price. Patience is key.
It’s important to understand that paying a dividend is at the discretion of the company. They can choose to cut or suspend the dividend altogether. Therefore, it is important to understand the history of the company before investing, particularly if it’s for the dividend. A qualified Wealth Advisor can help investors identify which companies have historically paid and increased their dividend and help avoid companies that may be at risk.
Please be sure to consult with a professional before undertaking any investment decision.
Derek Fuchs is a Senior Wealth Advisor and Portfolio Manager with Scotia Wealth Management based in Red Deer. He writes this column to help educate and inform local investors. Have a question? Email Derek at derek.fuchs@scotiawealth.com anytime.