Making money when stocks are falling isn’t easy. Sure, I can try and outperform the market by picking specific shares that could do well. Or I can make money by shorting a stock. However, there’s another way I can profit even if the market falls, thanks to passive income via dividends.
Lower share price, higher yield
To understand why a falling market isn’t always a bad thing, I need to be comfortable with the dividend yield calculation. It’s measured by dividing the share price by the annual dividend per share. Given that dividends only usually get paid a couple of times a year, the main driver day-to-day in the movement of the dividend yield is the share price fluctuation.
If the share price falls and the dividend per share hasn’t changed, the dividend yield increases. For example, with a share price of 100p and a dividend of 10p, the yield is 10%. But if the share price drops to 80p, the yield rises to 12.5%.
There are real life examples of this in the FTSE 100. The Taylor Wimpey share price has dropped by 37% over the past year. The dividend yield has jumped from 5.5% a year back to 8.32% now. BT Group shares have fallen by 27%, with the dividend yield jumping from 1.5% to 6.08%.
The dividend per share figure has influenced the yield movements as well when I look at things over a one-year period. But the key point here is that a drop in the value of the stock can give me a much more attractive dividend yield.
Higher passive income potential
As an income investor, the higher the dividend yield, the more bang I get for my buck. The amount of passive income I’ll generate will be greater than if I pick lower yielding options.
Buying these type of stocks helps me in several ways. When I add the company to my portfolio, it’ll help to increase my overall yield.
The income generated from the stock in 2023 can also help me to offset unrealised losses from negative share price movements. Let’s say that by the end of this year, my investment pot is down 5%. But if my dividend yield has been an average of 6%, I’m still up for the year.
Finally, I can reinvest the income from dividend stocks when I get paid. This helps to compound my future dividend payments, creating a snowball effect for 2024.
Being aware of stumbling blocks
This all sounds great, but I do have to remind myself of the risks. If stocks continue to fall aggressively, I could be in a significant unrealised loss that could take years before it recovers.
A company might also struggle in the current economic situation and be forced to cut the dividend. Not only would this leave me without income, but the share price would likely tumble further.
I can try and reduce the impact of both factors by splitting my money around various shares. This means I won’t be overly exposed to any one firm.
