How to Protect Your Dividend Income

They plummet, then they soar — this fall’s stock gyrations can make your head spin. Investors have long been told to just wait out the downturns. And, indeed, the broad market has always gone to new highs after the worst crashes, even if some stocks never recover.

That’s fine for investors who are well-diversified and have time to wait for a recovery. But what about the fixed-income retiree more eager for income than long-term growth? How do you make sure your dividends and interest earnings will keep flowing even if asset prices plunge?

“Recently, it seems that all news is interpreted as bad news, as the current bull market ages,” says Robert R. Johnson,” finance professor at Creighton University in Omaha, noting that no one can be sure when a market will peak or plunge. “This has to be the most unloved bull market of all time, and many investors seem to be anticipating its ending and negative sentiment could actually make it happen.”

[See: 10 of the Best Stocks to Buy for 2019.]

After all, the bull market for stocks is 10 years old and showing its age in recent volatility. Bonds, too, are under threat as rising interest rates make older, stingier bonds less attractive, driving down prices of ones you may already own.

Experts’ views on market and economic prospects run the gamut, from those who think everything is fine to those who expect the sky to fall, with the odds favoring something unpleasant in between. Johnson cites the dangers of a continuing trade war with China.

“I think the odds of an economic recession in 2019 are fairly low and most economists agree,” he says. “Bloomberg’s U.S. Recession Probability Forecast index puts the probability of recession in 2019 at 15 percent and I think that is about right. Still, most economists agree that the economy will slow down in 2019 and that economic growth will be at a more pedestrian 2.6 percent.”

But as uncertain as the future is, the retired investor focused on income can consider some strategies to keep the cash flowing. The trick is to avoid giving up too much income in exchange for safety.

If share prices fall but dividends keep flowing, the income-oriented investor will be all right if it’s not necessary to sell shares before a rebound. The danger is if a price plunge comes amid an economic slowdown that hurts corporate earnings enough to cause dividend cuts. There have been 11 economic cycles since 1945, with the average expansion lasting 58 months and the average contraction 11 months, Johnson says. To be safe, an income-oriented investor should plan for a down period lasting a couple of years, many advisors say.

Experts say certain dividend payers like utilities firms and consumer staples firms are safer than others, because the companies sell products and services customers usually buy even if the economy slows. Numerous funds specialize in these sectors, such as Utilities Select Sector SPDR ETF (ticker: XLU) and Consumer Staples Select Sector SPDR ETF ( XLP).

Johnson says he likes the “dividend aristocrats,” a list of S&P 500 stocks that have raised dividends every year for at least 25 years. Some funds specialize in those stocks, like the ProShares S&P 500 Dividend Aristocrats ETF ( NOBL), yielding 2.2 percent. Some of the 53 stocks on the current list pay considerably more, like AT&T ( T), at about 6.5 percent, and AbbVie ( ABBV) at 4.79 percent.

[See: 9 FAQs About the Next U.S. Recession.]

Note that a big dividend does not guarantee a great return; AT&T is down 16 percent this year. If the dividend stays the same while the share price falls, the yield goes up. So a big dividend can be a sign of trouble. But investors who are confident the dividend will hold steady or rise can get a good deal when the share price is down.

Chris Tuck, a planner with SJK Wealth Management in Doylestown, Pennsylvania, says investors should check for a low dividend payout ratio, the percentage of earnings paid as dividends. A lower ratio means the company may well keep the dividend even if earnings fall, while a high ratio means the dividend might be cut.

“Do companies payout more in dividends than they earn?” he says. “That can be a warning sign to a future dividend cut. Also check the companies’ debt level. If they are highly levered, interest expense could start to jeopardize the dividend.”

Bond investors have proven techniques for reducing risk. One is to switch to safer bonds — those with higher ratings that mean less risk they’ll default and stop paying interest or returning principal.

“This is an excellent time to shorten duration and increase credit quality,” says Douglas A. Kartsen, an advisor at DAK Financial Services in Avon, Connecticut. “Interest rates will continue to rise.”

A bond or fund with a three-year duration is likely to lose 3 percent of its value for every 1 percent rise in prevailing interest rates, while a bond with a 10-year duration would lose 10 percent.

Tuck prefers owning individual bonds to funds when the market looks risky. The investor can hold a bond to maturity, when principal is repaid, while a fund never matures because it must have an average maturity that stays the same, and will sell bonds when their maturity gets too short, even if they must sell at a loss.

Other strategies are pretty familiar to long-term investors: build up a good rainy-day fund, make sure the portfolio is well diversified so you won’t be derailed by the collapse of one holding or asset class, and tighten spending.

Experts say it’s especially important to avoid spending commitments that cannot be trimmed, like taking on a bigger mortgage.

[Read: What Are Dividends and How Do They Work?]

Johnson also cautions against what looks like an easy solution to a cash-flow shortage: starting Social Security benefits. The monthly income is much bigger if you wait — 8 percent larger for every year you wait after your “full retirement age,” which is 66 or 67 for most people. You’re unlikely to find a return that large in any other guaranteed investment.

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