The Best Way to Invest When the Stock Market Is Plunging

Source: Pixabay.

Forget the fact that the broad-based S&P 500 tripled from its March 2009 lows. All that matters right now to some investors is that the S&P 500 has lost about 7% of its value in a matter of a month, and traders are terrified.

Having watched CNBC at 3 a.m. (what can I say -- I'm a night owl) this past week, most of the programming early in the week was devoted to whether or not the market would continue plunging. And why did CNBC likely take this route with its programming? The answer is that many traders allow their emotions to get the better of them. In other words, the best way to invest money for some traders is to simply hop aboard the latest news-driven story and hang on for dear life until the next one comes along.

Though this strategy of trying to time the market based on news events has worked for a few years, given that there have been no sizable corrections, it's not a successful long-term strategy, as recessions and stock market contractions are a natural and unpredictable component of any economic cycle.

This is the best way to invest money in a falling market
So this leaves investors like you and I, who aren't trying to time the market and swipe a $0.10 gain on a stock, wondering: What's the best way to invest money when the stock market is plunging?

I believe the answer to that question is actually easier than you might think: turn to high-quality dividend stocks.

Source: TaxRebate.org.uk via Flickr.

Dividend stocks serve multiple purposes for investors. Just as a dividend payment is the icing on the cake in a bull market, in a falling market a dividend payment can act as a hedge against nominal share-price losses. Remember, as investors we're looking at where the stocks we own will be five, 10, or even 30 years from now. If a dividend stock we own loses 15% in a month, it's not really a concern so long as the quality of the business model or the management team hasn't changed.

That leads to my second point about dividends: They're a sign of strength. A company that can consistently pay and even grow its dividend on an annual basis is telling investors in the best way that its business model is healthy and that it values its shareholders. In turn, long-term investors tend to buoy these stocks in a falling market because the dividends can help hedge their nominal losses, and because their business models are usually strong enough to survive even the worst recessions.

Dividends also have a third and often overlooked advantage: the ability to be reinvested. While pocketing your dividends in your bank account certainly helps ease the pains of a falling market, reinvesting those dividends back into the same stock can actually reap considerably higher returns years down the road.

Three stocks to buck the downtrend
What do I mean by high-quality dividend stocks? Let's have a look at three examples that could have you outperforming if the market continues to sink.

Source: Aflac.

Call me a "quack" if you like, but supplemental insurance giant Aflac (AFL 0.28%) is a great example of a sustainable business model in bull and bear markets. Insurers are among a few unique sectors that have pricing power in any economic environment. Higher premium payouts serve as a justification for a company like Aflac to boost its premiums. Conversely, low-payout environments can still lead to higher premiums, because an insurer can use the fear of another catastrophe as justification to boost its cash reserves. This makes the insurance business quite profitable and has allowed Aflac to increase its dividend for 31 consecutive years. Given its current yield of 2.6% and compound dividend growth rate of 14.6% over the past decade, an investor willing to reinvest their dividends could double their investment in just over 11 years.

Source: Flickr user Randy Robertson.

If insurance sounds too risky for your tastes, then perhaps you can cool off with a water utility company like American States Water (AWR 1.75%). Why a water utility? Though water isn't perceived to be as valuable as other commodities, we do need it to survive! This makes water a basic-needs good that tends to be used in similar quantities regardless of how well or poorly the U.S. economy is doing. And the fact that the U.S. water and wastewater business tends to be regulated means predictable profits and cash flow, which investors love. It also doesn't hurt that American States Water has increased its dividend for an incredible 60 straight years. Based on its current yield of 2.7% and its 6.8% compound dividend growth rate over the past decade, reinvesting your dividend would double your money in 15 years.

Source: AT&T.

Lastly, if technology or consumer goods is more your thing, then perhaps a company like AT&T (T 1.17%) can help you weather the storm. AT&T has your bases covered with the best brand loyalty of any wireless service provider, according to Brand Keys. In addition, the products and services it sells are quickly becoming basic-needs products that consumers can't live without, enhancing its pricing power. Given AT&T's 30-year streak of increasing its dividend, a current yield of 5.4%, and a 10-year compounded dividend growth rate of 3.9%, investors can expect to double their initial investment based on the dividend alone in about 10.5 years.

Stick to your game plan and prevail
In sum, the best way to invest money when the market is plunging is to stick to remain calm and seek out high-quality dividend stocks. This way you can continue to hedge any nominal losses with dividends received or reinvested dividends -- and enjoy a good night's rest without fretting over what the stock market will do tomorrow or the day after.