When the Going Gets Tough, Own These Stocks

Right now, millions of people are packing up their cars, filling up their gas tanks, and hitting the roads for a Memorial Day vacation. And the topic they'll surely discuss on those long car rides is ... the economy!

Well, maybe not, but food prices have rocketed higher -- and they seem downright quaint compared with gasoline prices. That's put a crimp into American spending habits and effectively slowed the entire economy. And we likely still haven't turned a corner. This is from a Reuters story published yesterday:

The economy is still facing a possible recession this year, with any recovery stunted by inflation that prevents the Federal Reserve from cutting interest rates again.

You guys are full of joy and cheer
We're not sounding the alarm bells of panic simply to sound the alarm bells of panic. Rather, today's economic climate should be a reminder that you should always keep your portfolio prepared to weather tough times.

Doing so will mean different things for different people (depending on your investment timeline and tolerance for volatility), but a recent study from Standard & Poor's of recessions from 1945 to 2002 (which was reported in Fidelity Investor's Quarterly) reveals one surefire way that should work for everybody.

Buy defensive stocks
According to Investopedia, a defensive stock is one that "provides a constant dividend and stable earnings regardless of the overall stock market." You can generally find such stocks in defensive industries, which include consumer staples, health care, utilities, and financials.

While that last category surely wouldn't have helped you lately, the aforementioned S&P study shows just how well these spaces do during recessions:

Source: Standard & Poor's, as quoted in Fidelity Investor's Quarterly.

Why this works
There are two core reasons why these four industries tend to do so much better than the market during lean times:

1. They're reliable. These companies make the products that people buy even when their wallets are being pinched. In other words, shampoo, razors, medicines, or electricity for their homes -- and not cigarette boats.
2. They pay dividends. Dividends mean you get a steady return from a stock regardless of what the market is doing. So, all else being equal, you enjoy a head start over the stocks that don't pay dividends.

Of course, when you're looking for reliable companies that pay dividends, you want to make sure your company has both paid and increased its dividend steadily over a period of at least 10 years. Only then are you getting a track record you can trust.

So, with those as guidelines, here are six defensive dividend stocks that shouldn't let you down even when times get tough:

Data from Capital IQ.

Rock out
The opposite of these defensive plays is a penny stock like Elixir Gaming Technology (AMEX:EGT), which is a small and unproven company looking to install slot machine halls in emerging economies such as Vietnam, Cambodia, and the Philippines. While we're very interested in the company and its enormous potential, if you fret over volatility and the potential for total capital loss at all, you should stay far away from Elixir and any other stock like it -- particularly in a tough market like this one.

What's more, if you're a beginning investor, you should only start getting interested in a company like Elixir after you've built a rock-solid defensive foundation in your portfolio and have a sound asset-allocation game plan that tells you how much money you can afford to risk in volatile, small, and unproven stocks.

Robert Brokamp, advisor of our Motley Fool Rule Your Retirement service, has a new report detailing "Four Great Investments for the Long Term." If you'd like to see those specific recommendations, as well as Robert's asset-allocation and model portfolio advice, we offer a free 30-day trial without obligation to subscribe. Just click here to get started.

Neither Brian Richards nor Tim Hanson has ever seen the tough get going anywhere in particular. Neither owns shares of any companies mentioned. JPMorgan is a Motley Fool Income Investor recommendation. Wal-Mart is an Inside Value pick. Elixir Gaming is a Motley Fool Hidden Gems Pay Dirt selection. The Motley Fool has a disclosure policy and everything.