Beat the Market Doldrums

We Fools tend to be unabashed stock market junkies. When we're not at work deconstructing cash flow statements and calculating intrinsic values, we like to settle in for some light recreational reading -- with Ben Graham and David Dodd's Security Analysis. That is not to say that we have no outside interests. I, for one, have felt the pull of the ocean lately, and over the past year most of my surplus income has been diverted into what I like to call the "Sailboat Account."

I don't know a halyard from a rudder, so I'm going to need a crash course before I can finally take the helm. But after subscribing to several sailing magazines and spending some time on the water, I have learned one thing: The whole process is much more enjoyable when the wind cooperates.

Similarly, investing -- you knew this would tie back to stocks sooner or later -- is much easier when the markets give us a comfortable tailwind. Naturally, even an inexperienced investor can stay on course when the broader markets are soaring. And it is also possible to make headway in a down market, when sinking valuations present unusually good buying opportunities.

It's the flat market -- when stocks seem to be stuck in place for months or years -- that can be the most frustrating.

No wind in the sails
Given their wild day-to-day gyrations, it is easy to think that stocks are always headed somewhere, either forward or backward. However, volatility can often mask the fact that there is actually a third direction -- sideways. In many cases, all of those erratic movements counterbalance each other, eventually leaving the market right where it started.

It is not uncommon for the major averages to experience one sharp price swing after another, but essentially remain confined to a very tight trading range. With all of those daily zigs and zags, it may seem like stocks are in motion, while in reality they are -- like a sailboat stalled without a breath of wind -- going nowhere fast.

In days gone by, mariners would often become stranded in certain regions that were notorious for their lack of wind, and they were often forced to throw their horses overboard to conserve water. These areas came to be known as the "horse latitudes." Fortunately, when Mr. Market decides to still the winds, investors need not resort to such drastic measures to keep their portfolios sailing along.

Make some waves
We all know that the markets can -- and do -- grind to a halt. However, some may not realize that stocks can drift lazily along with the current for years before finally deciding on a direction. As a prime example, let's go all the way back to 1964: Lyndon Baines Johnson was elected President, the St. Louis Cardinals won the World Series, and the Dow Jones Industrial Average closed at 874.

Now flash forward to 1981, when IBM (NYSE:IBM) launched its first PC, and a new video game called Pac-Man was all the rage. After a late-summer swoon, the Dow Jones went on to finish the year at 875. Over the span of nearly two decades, the popular benchmark changed course many times, but ultimately it gained a grand total of just one point.

As long-term investors, we are conditioned to accept prolonged periods of flat or negative returns, but 17 years of taking one step forward and one step back can be trying for even the most patient. Fortunately, it is still possible -- if not easy -- to capture substantial profits in this challenging environment. The simple act of collecting a steady stream of dividend payments can power your portfolio forward, even when the market appears to be stuck in neutral.

A recent study by Hartford provides a textbook example. In the 10-year period between Nov. 14, 1972, and Oct. 12, 1982, the Dow Jones Industrial climbed all the way from 1,004 to 1,004. Not surprisingly, a $10,000 investment in the Dow would have shown very little growth, with an ending value of just $10,376.

However, while the underlying share prices remained flat, most of the Dow components themselves continued to dish out attractive dividends quarter after quarter. As a result, the same $10,000 investment with dividends reinvested would have grown to $17,640. In other words, an investor could have pocketed a 76% cumulative return over that period, even with virtually zero capital gains.

To drive home the point, let's take a closer look at the last two years. From the end of 2003 through the end of 2005, the Dow Jones advanced less than 3%, inching from 10,453 to 10,717. Nevertheless, as the table below clearly demonstrates, many Dow components still managed to deliver excellent total returns.

By definition, an average is just an average, so it stands to reason that some members of the Dow -- like those above -- would gain ground during this flat period. However, it certainly didn't hurt that each also offered an above-average (and growing) dividend payout.

Cruising into port
Whatever your final investing destination, it is usually a good idea to anchor your portfolio with a few income-oriented stocks. As we have seen, they can keep you moving in even the calmest of seas. However, they tend to perform equally well during adverse conditions, providing some buoyancy when the rest of the market seems to be foundering. And contrary to popular opinion, income-oriented investors generally need not sacrifice much upside potential to gain this downside protection.

Looking for an experienced skipper who can steer your portfolio through any weather conditions? As captain of Motley Fool Income Investor, Mathew Emmert is always on the lookout for the market's most promising dividend-paying stocks. Since embarking in 2003, he has guided his passengers to a 16.2% average return, easily outrunning the S&P 500.

Climb aboard today, and you're welcome to cruise for the next thirty days free of charge. Oh, and if you happen to know how to sail, I'd welcome any pointers.

Fool contributor Nathan Slaughter should be able to afford a boat sometime in the next 30 years. He owns none of the companies mentioned. The Fool has a disclosure policy.