Why Dividends Hold Up in Recessions

A recession may be forthcoming, according to new research conducted by the Bank of America1. The threat of a recession, which has been looming for several months, leaves many investors wondering what they should do with their money. One tried-and-true option for investors anticipating a downturn is to diversify into dividends. Companies choosing to pay dividends to shareholders typically make them quarterly as a share of overall earnings in the form of cash or reinvestment in more stocks. After each recession in 2001, 2008, and 2020, dividends averaged a 4.5% gain2 above the overall market.

The Bank of America study1 analyzed 30 U.S. recessions since the late 1800s and found three common market characteristics that likely signal recessions. Two of the three signals have recently occurred in the U.S., with the third likely before the year’s end.

The first signal that has come to fruition is a steepening of the U.S. Treasury rate yield curve after an inversion (short-term rates yielding more than long-term rates). According to Bank of America1, eight out of ten yield curve inversions have preceded recessions over the last century.

The second signal began in late 2022, when banks invoked the first credit tightening since the start of the pandemic. This indicates that banks are becoming less willing to lend money. The BofA report1 shows that credit conditions typically worsen about a year before a recession.

The third signal that has yet to occur is a lowering of interest rates, which the report shows have been followed by 25% more downturn1 in historical recessions. The Federal Reserve has not lowered rates yet, but indicated that their most recent rate hike in May would be their last for the time being.

If we are nearing a recession, dividends possess several characteristics3 that make them smart investment decisions in a downturn. Investors of dividend-paying stocks receive a total return from both the share value and dividend yield (dividend/price). If the share value increases, the total return increases on top of dividend yield. Even if the share value falls, as it might in a recession, the investor doesn’t incur a loss unless the share value falls by more than the dividend yield. A dividend yield of 5-10% essentially gives the investor a 5-10% downside cushion before incurring a loss. Investors are therefore more likely to stay invested through a recession, making dividends less volatile. Dividend-paying stocks also effectively create their own stock price floor because more investors are likely to buy low-value stocks when dividend yields are higher.

Not only are dividend investors likely to hold up better in a recession, but the companies offering dividends likely will as well. That’s because many companies that offer dividends share several characteristics4 that make them more resilient. Because dividends are usually paid out to shareholders from “leftover” cash on a consistent basis, these companies tend to be more stable with greater financial discipline. These companies are usually more mature, well-established entities with high cash flow.

Whether a recession comes to fruition or not, diversifying an investment portfolio with dividends adds necessary stability and consistent income that can make up for losses elsewhere while providing a respectable cushion for various market scenarios. TrueShares Low Volatility Equity Income ETF (DIVZ) is concentrated in well-managed companies across a range of sectors and seeks above-average dividend yield. Because we know that not all dividends are created equal, DIVZ is actively managed and relies on fundamentals to ensure sustainable, long-term total returns for investors throughout the ups and downs.