After a record sell-off in trading on Monday for the FTSE 100, volatility is back after a couple of quieter days late last week. Given the larger sell-off we have seen from levels of 7,500 only a month ago, it is definitely worth thinking about how to position your stock portfolio in case the current correction becomes a crash.
Do not take this as a doom and gloom article by any means. I think that the risk sentiment pervading global stock markets at the moment will blow over once the coronavirus starts to recede. But until that happens (it could take several months), or if I am wrong, here are a few reasons why buying high-yielding stocks can be a good idea.
What are high-dividend-yield stocks?
Most companies within the FTSE 100 or 250 index pay out a dividend to shareholders on at least an annual basis. The dividend may change year-on-year depending on company performance. When you buy a share and receive a dividend, you can work out the ‘yield’ that this gives you. For example, if you paid 100p for a share that pays a 1p dividend, your yield is 1%. Usually if a stock yields above the FTSE 100 average (currently around 4.5%) it is classified as high.
Why buy high-dividend-yield stocks?
The main characteristic of a market sell-off is that the share price of the index constituents falls heavily. This is usually down to broader investor risk sentiment, and so is not always tied to the strength of an individual firm. The recent sell-off has highlighted this.
My first reason is that you may invest in a high-yield firm that is taking a hit via a lower share price. But this dividend should continue to be paid if the firm is still financially sound and not specifically impacted by the reason for the market sell-off. In this case, you will be receiving income via the dividend. This will reward you while you wait for the market to realise that the firm is ok.
Secondly, as a longer-term investor, holding on to a stock during a market tumble may mean you are facing an as-yet-unrealised loss on the amount you invested. Yet if you are picking up income from a stock via the dividend, this can help to offset any loss on the money you invested. This can work particularly well should the market downturn last for a long time. Remember, if you sell up now, that paper loss becomes a real one.
And thirdly, on a historic basis, the businesses that tend to pay higher dividends are more mature firms that have been around for a long time and are seen as safer investments overall. Examples of this are British American Tobacco and GlaxoSmithKline. Such companies are unlikely to generate large returns for investors from a rocketing share price, so need to reward those buying the share by paying a high dividend. I appreciate that a high dividend does not always translate to a high dividend yield, percentage-wise. But there are plenty of solid shares out there that do.
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Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.