Stock market crashes are uncomfortable, even for passive income investors. That’s because meltdowns tend to take most of the market down, including stable dividend stocks.
But for long-term investors focused on passive income, crashes can be absolute gold dust. Let’s break down why.
Sneezes and colds
The most simple reason is that when share prices fall, dividend yields rise due to their inverse relationship.
So, a £10 stock paying a 50p annual dividend yields 5%. But if a severe market panic knocks the price down to £7, and the dividend is still met, the yield jumps to 7.14%.
To put that in context, that’s the difference between £1,000 and roughly £1,430 in dividends respectively on a £20k investment. Or the difference between 2,000 and 2,857 shares.
During crashes, such sell-offs are commonplace. Even rock-solid businesses with dependable cash flows suddenly offer much more attractive income yields as investors rush for the exits.
And even if the crash is triggered by something across the pond, UK stock market investors often feel the pain. That’s because when America sneezes, the world catches a cold, as the old saying goes.
However, there’s an added kicker that could boost wealth even further. And this is the potential share price recovery that can happen once markets stabilise and money starts to flow back into high-quality stocks again.
Moreover, these returns would be totally tax-free if the investments were held inside a Stocks and Shares ISA.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Research is necessary
Of course, there are caveats here. Crashes are almost always caused by the prospect of a significant global economic downturn (worldwide pandemic, financial crisis, etc).
So companies that are going to be negatively impacted by this, which would be many, might justifiably be trading lower. In this scenario, some dividends would probably come under pressure.
It always pays to understand why a share price is suddenly falling. Not every dip is an automatic buying opportunity, and some shares can keep falling, leaving investors underwater for years even after dividends are paid.
An almighty yield
Let’s zoom in on the FTSE 100‘s biggest-yielder, which is pensions giant Legal & General (LSE:LGEN). This stock already sports a monster 8.3% dividend yield. Over the next 12 months, it’s expected to edge up to 8.6%.
Now imagine that a broad market wobble takes the share price down 20%. In this case, the forward-looking yield would balloon above 10.5%!
Were the dividend to hold, this would see investors pocketing more than £2,000 per year in passive income from a £20k investment.
Again, though, investors should be mindful of the risks here. If a severe recession engulfed the UK — because President Trump actually ramped tariffs higher, say — Legal & General’s assets under management might fall significantly.
That’s because many investors tend to pull their money out of the market during downturns.
Even so, I would still be confident that the firm would pay its dividend in this scenario. It has already earmarked over £5bn for dividends and share buybacks over three years, and is well on course to deliver this.
Therefore, I think this FTSE 100 income stock is worth considering today, and even more so if a market wobble suddenly sends its yield soaring above 10%.
