How Your Portfolio Will Recover

The market has fallen by 40% from its highs a year ago, but that doesn't mean you'll never again make money investing.

If anything, the Wall Street Panic of 2008 means you have an even better chance of seeing some extraordinary long-term returns.

Winners through the crashes
In the past 25 years, there have been at least three major market corrections:

  • Black Monday in 1987.
  • The bursting of the dot-com bubble from 2000 to 2002.
  • The bursting of the subprime and credit bubbles in 2008.

In each one, investors racked up significant paper losses (and realized them, if they sold low) as the market crashed. Yet investors also racked up significant gains coming out of each of the market corrections. Why? Three reasons.

  • Cheaper stock prices mean you can buy more shares of good companies for every dollar you spend. Since stock prices are based on the market's perception of a company's future performance, the overall pessimism works in your favor.
  • Because share prices are low, reinvesting dividends (which don't fluctuate with share price) boosts your investment even further, because each reinvested dividend buys more shares.
  • When market sentiment returns to a more even keel, bringing share prices up with it, you'll see the best returns from the shares you bought at the lowest prices.

In other words, the more the overall market has been hammered, the better your chances of profiting as it recovers.

Let's revisit door No. 2
That market crashes are good times to buy in isn't news -- we've all heard the adage "buy low and sell high." But the part dividends play in this story isn't as well-known.

Because dividends are based on a company's actual results and its management's projections for its operational future, a maintained -- or even raised -- dividend signals that the underlying company is healthy -- no matter what its stock price does. That's a nice reassurance during a period as volatile as this one.

But dividends can do more than signal companies worth buying -- reinvested, they also juice your long-term returns. In fact, historically, reinvested dividends have represented more than 40% of the market's long-term returns -- and when the market has slashed prices the way it has lately, reinvested dividends can do even more. Take a look at the difference they'd have made to investors in these companies.

Company

DividendYield

25-Year Growth of $1,000, Excluding Dividends

25-Year Growth of $1,000, Dividends Reinvested

Dividend Difference

PPG Industries (NYSE: PPG  )

4.5%

$9,011

$22,723

152%

Emerson Electric (NYSE: EMR  )

4.1%

$10,208

$23,151

127%

3M (NYSE: MMM  )

3.1%

$6,184

$13,258

114%

General Electric (NYSE: GE  )

6.6%

$8,747

$16,991

94%

Coca-Cola (NYSE: KO  )

3.3%

$21,143

$35,853

70%

Air Products & Chemicals (NYSE: APD  )

3.1%

$10,779

$18,228

69%

Automatic Data Processing (NYSE: ADP  )

3.3%

$16,431

$24,776

51%

Strong and sustainable dividends can take already good returns and make them spectacular.

More powerful than before
When share prices are down, as they are now, those dividends matter even more. As huge as the dividend difference is in the examples above, it'll be even bigger coming out of a market downturn. Over the long haul, there's nothing like dividend reinvestment to help your nest egg recover and resume its growth.

At Motley Fool Income Investor, we're taking full advantage of this market downturn to pick up some of the strongest dividend-paying companies around at dirt cheap prices. We've used the power of those payouts to stay ahead of the market as it has fallen, and we're planning to keep using those dividends to compound our growth more quickly during the recovery. To see our most recent selections, click here to start your free 30-day trial -- there's no obligation to subscribe.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric. PPG Industries is a Motley Fool Income Investor selection. 3M and Coca-Cola are Inside Value recommendations. The Fool's disclosure policy is looking forward to a recovery.


Read/Post Comments (5) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 12, 2008, at 6:18 PM, steinbrock wrote:

    I understand that a large part of the losses in the market are due to people selling out and, in particular, mutual funds must sell off positions to pay those bailing out, which causes those funds to drop in value. However, near the close of the market traders jump in and buy depressed stocks, which helps the market to stop some of the losses. However, there have been several days of $400. dow jones losses fed by the subprime mortgages, big name brokerage houses going belly up or banks merging. This, of course, increases the panic. Let's hope the turnaround comes soon, hopefully with the Jan. 20th inauguration of Barak Obama to give us confidence.

  • Report this Comment On November 12, 2008, at 7:45 PM, MRCarden wrote:

    I'm not sure about the math in the examples of dividend reinvestment gains. Are they adjusted for taxes that have to be paid each year, regardless of whether one reinvests or not? How about the opportunity cost of not investing the dividends in other faster growing assets? I would agree that one achieves a dollar averaging share cost over time when reinvesting dividends, but I don't think the comparison is quite as simple as is shown in the chart. I stopped reinvesting dividends several years ago when it became too time consuming to track the cost basis of the dividend purchases each quarter, for capital gains purposes. I just take the dividends now and put them into a general reinvestment pool (or spend them!).

  • Report this Comment On November 12, 2008, at 9:25 PM, TMFBigFrog wrote:

    Hi MRCarden,

    .

    Good question. No -- the examples do not include the tax effects of dividends. The implicit assumption is that either the money is invested in an IRA, 401(k), or other tax deferred account or that the taxes are paid out of another pocket.

    .

    Best regards,

    -Chuck

  • Report this Comment On November 14, 2008, at 5:24 PM, cosecha wrote:

    I have one stock that has slid from about $46 to about $11. I can't find anything wrong with the company. The dividend yield is now about 33%. I have always thought that anything yielding 33% was in danger of collapse. I don't know what to do. I am certainly willing to identify the company but don't know if I would get your site in trouble by doing that.

  • Report this Comment On November 15, 2008, at 1:14 PM, pauldobson wrote:

    Dividend sounds too good to be true especially if there is nothing wrong with the company. A lot of company names get mentioned in the MF articles. Should not be a problem to identify the company.

    Regards-Paul

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