Together, six years ago, we watched the beginning of a downturn that cut the S&P 500 in half and dropped the Nasdaq nearly 80% off its highs. It was a maddening time for investors. Telecom and energy executives were caught with their hands in the corporate cookie jar. Technology shares plummeted, with hundreds of companies vanishing from sight. Very few bear markets in U.S. history have hurt so much. Comverse Technology (NASDAQ:CMVT), a bull-market darling, has fallen from $120 per share to $20 today. And LTX (NASDAQ:LTXX) traded from north of $50 all the way down to $5.

Just how painful was it? Ask Nobel Prize-winning psychologist Daniel Kahneman, who proved that humans are innately loss-averse, particularly when it comes to money. Emotionally, losses hurt us far more than gains give us pleasure. Naturally, then, those massive declines crippled tens of thousands of investors, many of whom will -- sadly -- never throw the one-two punch of savings and investment again.

It doesn't have to be that way.

Win with moderate risk
The solution is not to bail out of the market altogether, nor to seek shelter exclusively in bond funds. With the right perspective and useful tools, you can strengthen your stomach and beat the market -- because you'll do so without assuming huge risk. I know that's true because it's being done every year by the world's master investors -- from Buffett to Lynch to Tillinghast to Miller.

Those who take the biggest risks and buy what's hot today usually take the biggest hits in down markets. In the meantime, a host of methodical, smart, and contrarian investors ring up great returns, even through tough markets, by adhering to Warren Buffett's first rule of investing: Preserve capital.

Today, I want to focus on one sweet way to preserve capital and beat the market. The general principle is simple: Buy stocks that have paid uninterrupted dividends for years.

Consistency to victory
Let's investigate this idea by looking first at Procter & Gamble. P&G has paid a stable dividend since 1890. Yep, you read that correctly -- the company has paid dividends steadily for the past 116 years. Some of you may be thinking, "Bor-ing!" But over the past 15 years, P&G has returned 14.8% annually, turning a $10,000 investment into more than $80,000 today. And when stocks like this temporarily decline, as they did during the summer's market swoon, owners still get the dividend payment, inspiring all of us to be patient and calm -- two of the primary traits of the world's greatest investors.

Then there's BB&T (NYSE:BBT), which has paid a dividend since 1903. Or Franklin Resources (NYSE:BEN), which has paid a dividend since 1981. Or boring H.B. Fuller (NYSE:FUL), which has raised its dividend every year since 1969. Fuller, BB&T, and Franklin have ranged from steady to market-crushing, returning 9%, 19%, and 21%, respectively, per annum over the past 15 years.

This sort of investing success is happening every day in our Motley Fool Income Investor advisory service. Using a combination of outsized yields and capital gains, analyst James Early and his portfolio of stocks is beating the market by nearly seven percentage points since the newsletter's 2003 inception.

But James isn't picking just any old high yielder. He believes that to outperform the market, you have to find financially strong, well-managed, undervalued companies that pay dividends. Why take a chance on Joe's Next-Generation e-Hot Dog Stand -- with its jumpy beta, battered balance sheet, and 50/50 chance of going bankrupt -- when you could invest in a stable ship that returns profits to shareholders and provides capital returns over the long term?

It's a tried-and-true formula, and if you follow it, you'll save yourself from the market's volatility.

The Foolish bottom line
There are loads of great dividend-paying stocks, but they're not the market's most popular. In fact, you usually have to go digging to find them. But you can see James' two newest picks when they're released this afternoon at 4 p.m. EST and his favorite stocks for new money now, just by clicking here.

This article was originally published as "Do You Have the Stomach to Beat the Market?" on June 10, 2005. It has been updated.

Tim Hanson does not own shares of any company mentioned in this article. No Fool is too cool for d isclosure .