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What Happens to Dividends During a Recession?

No matter how you try to solve the problems with dividends during a recession or make it appear as if there isn’t any problem, recession has a huge impact on dividends. However, you need to understand that a market downturn does not automatically mean your money will be lost.

It is possible to benefit from equities even when markets are tumultuous. In these cases, companies that preserve or grow their payouts can offset the drag created by companies that drastically reduce their dividends.

Does this imply that nothing can be done to assist? How about diversifying your portfolio by buying numerous dividend-paying stocks with regular pay outs, what happens then? 

Read on to get a better clue on what happens to dividends during a recession and the best dividend stocks for a recession.

What Are Dividends?

Dividends are payments provided by a company to its stockholders in exchange for an investment in the company. The payments are made to stakeholders by a corporation.

When a firm makes a profit or has a surplus, it can decide to pay a dividend to its shareholders.

Can a Stock Stop Paying Dividends?

Yes, companies can stop paying dividends during a recession if they believe it is necessary. A corporation that is losing money and is in the midst of a severe economic slump is unlikely to pay dividends.

Economic or market factors may also influence a company’s decision to keep earnings. 

What Is a Recession?

A recession is a period of downturn in economic activities. It occurs when falling economic performance affects the entire economy for an extended length of time.

What Causes a Recession?

A significant reduction in consumer spending frequently precedes a recession. Most recessions, on the other hand, are brought on by a complex set of macroeconomic variables, including:

  • A quick loss of investor confidence, including a loss of confidence in the economy and investments.
  • Manufacturing orders in a state of decline.
  • Excessively high-interest rates.

How Long Do Recessions Last?

A recession can continue up to 11 months, but it lasts for an average period of 6 months. Recessions and depressions are periods of economic decline, but their intensity, duration, and economic impact differ.

While an economic recession may endure for some months, an economic depression being a more severe downturn, can endure for years. Depressions last longer and have more negative consequences than a recession.

Depression is defined as an economic slump in which the real gross domestic product (GDP) falls by more than 10%.

The Impact of a Recession on Dividends 

Dividend investing has been an effective long-term strategy for portfolios and for good reason. A lot of it stems from their built-in ability to lessen the effects a recession causes on one’s financial health.

They are a terrific recession fighter for portfolios because of their consistent payouts and slim likelihood of defaulting on payments. The following are some impacts a recession can have on dividends.

Dividends Fall

When a firm decides to start paying monthly cash dividends to its shareholders, its stock begins to trade on the stock market with less price volatility. During a recession, dividend payouts may decrease or stop in lieu of the stock price falling.

This is a sign that the firm is decreasing profits and may be running short on capital. Either way, a dividend decrease or stop could be an indicator that that firm is struggling.

Firms Can Cut Dividends at Any Time 

According to the Securities and Exchange Commission, dividends can be cut at any time. But the risk of this increases during a recession.

Dividends fall as earnings fall because firms pay cash dividends from their earnings. Cuts or eliminations of dividend payouts are an investor’s worst enemy.

A recession increases this risk since dividends are paid from a company’s excess cash flow, and when the economy is in a slump, these funds may be scarce. Dividend payments may also be cut for more positive reasons, such as planning a large purchase or stock buyback, paying secured and unsecured creditors.

An Overall Decrease in Share Prices and the Company’s Outlook 

As companies try to stay profitable during the recession phase of the business cycle, income, employment, and stock values may fall. Internally, there may be a variety of repercussions on employee morale and productivity, as well as putting the company at risk of a takeover.

Advantages of Having Dividends During a Recession

What then are the advantages dividends could have during a recession? Let’s look at the possible benefits of dividends during a recession.

Offset Inflation 

During a recession, inflation falls. Dividends are frequently used to help minimize portfolio risk by attempting to control inflation deliberately. 

Dividends are a great way to hedge against inflation.

Possibility for Higher Returns

Higher returns are possible since some stock market sectors are frequently resistant to economic cycle swings. Businesses that have historically weathered recessions have had generally consistent demand in both good and poor times, helping them to weather the storm.

Building a broad portfolio requires investing in companies from a variety of stock market sectors, particularly those that are recession-resistant. Some companies that fall into this category includes those in essential industries like commodities.

Manage Portfolio Risks

Dividends are a risk management strategy for investors since they have a track record of providing above-average returns. Dividends play a crucial role in lowering portfolio risk and volatility.

In terms of risk reduction, dividend payments offset any losses incurred as a result of a stock price decrease.

Disadvantages to Having Dividends During a Recession 

Because recessions hurt the economy as a whole, you’d anticipate dividend stocks to suffer as well. Dividend stocks have long been a reliable source of income during times of economic downturn, but not all of them are. Before investing in dividends, there are several disadvantages to consider.

Risk for Loss

While dividends are used as a tool to offset losses on other investments, it is important to note from history that dividends have decreased before, during a recession. For example, during the 2007-2008 financial crisis.

Dividend cuts represent a loss of income as well as capital. If investors sell their positions instead of waiting for the market to rise after a crash, they risk losing money.

Due to margin calls, those who purchased shares on margin may be forced to liquidate at a loss.

Firms Can Stop Payments 

Another risk of owning dividends during a recession is that the payments may be discontinued just when you need them the most. Companies that retain payouts may significantly reduce or abolish their dividends. 

Bounceback Period Can Be Long

The length of a recession’s recovery period varies depending on the cause of the downturn. Uncertainty is always a setback in business, and a recession that impacts the entire economy can result in a considerable drop in activity that lasts more than a few months.

Recovery for the economy from this setback might be a difficult task because so many variables would have been impacted.

How to Prepare for Recession With Dividends

By taking steps to structure your investment portfolio, you may ease some of the stress that a recession brings. You want your investment to work for you both during and after the recession.

Knowing that recessions have ended with greater economic growth in the past, doesn’t make the idea of facing a recession any easier. While no one can anticipate when a recession will begin or end, you can prepare now to avoid much of the pain.

Make an emergency fund of three to six months worth of living expenses. If you owe money, be sure you have a plan in place to repay it. During a downturn, you’ll want to make sure your financial obligations don’t build up.

Look for ways to diversify your income. Some of these ways include side hustles. Additionally, allocate a portion of your portfolio to dividend-paying equities. 

It’s a good idea to review your investments regularly to see if you should buy more, stay on to your current position, or sell.

Protect Your Portfolio

When you grasp the secret to a successful long-term investment, which is capital preservation, you can secure your portfolio. While it may be hard to completely avoid the risks of investing in the stock market, safeguarding your portfolio can go a long way to assist.

Begin by diversifying your portfolio to include non-correlating asset types like bonds, commodities, currencies, and real estate alongside your equities. By adding dividend-paying stocks to this, it will balance out the risks taken through those other investments as dividends are considered a stable and safe investment decision.

Conclusion

Long-term investing is unavoidably subject to recessions. The best investing approach during a recession is to identify companies with stable business models amid the economic downturn.

Investors should be aware that while stock prices may be quite volatile at such times, dividends during a recession are often far less volatile. You can also learn how to diversify your portfolio to be prepared for any economic slump. But before you do anything, consult with a financial professional because you will need their assistance.