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How to turn a stock market crash into passive income paradise

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Given the backdrop of high interest rates and low economic growth, the recent arguments for a stock market crash within the next year do have some validity. Yet instead of panicking right now, I’d rather use the time to make some plans for different strategies. Passive income is always a goal of mine, particularly via dividend stocks. So if the worlds do collide, here’s how I can boost my earnings from beaten-down income stocks.

Picturing the scene

Firstly, let’s just run through what the situation could look like if things take a nosedive in the market. The FTSE 100 and FTSE 250 would likely be losing 1-3% a day in value, for a period of several weeks. During this time, it’s unlikely that any stock would be gaining value. Some investors would simply be selling everything.

Judging from the past market crashes, there tends to be a swift recovery from the lows. This isn’t to say that the market makes back all the losses just as quickly. This can often take months to do. But the period of being very oversold can often only last the space of a week or so.

The impact on dividend stocks

Like any type of stock, those that pay out income will be hit hard too. Yet there’s an important distinction to make, which is key for the strategy to work. I only want to buy the stocks that have been oversold out of panic, not the ones that are fundamentally weak.

For example, let’s say there’s a company that has debt problems that sells products to the public. Even if this firm pays a generous dividend, I’d be very cautious about buying. High interest rates and low customer demand could really put this business under cash flow pressure. As a result, the dividend could get cut.

Rather, I want to focus on buying companies that have simply been caught up in negative overall sentiment. Instead of the crash weakening the business, it’s simply a case of business as usual. Utility stocks is one area that comes to mind.

Making the numbers add up

When the share price falls, the dividend yield rises. This assumes that the dividend per share hasn’t changed, but given that most companies only pay out a couple of times a year, it doesn’t change often.

So in the case of a crash, rising yields is the main reason why I call it a passive income paradise. For example, take United Utilities Group. It currently has a yield of 5% with a share price of 921p. If a crash pushed the price down by 20%, the yield would jump to 6.18%!

So by being careful about which stocks I buy during a crash, as well as being mindful that I might have some unrealised losses from my capital for a period before the market recovers, I think that a crash is an opportunity for higher income potential.

The post How to turn a stock market crash into passive income paradise appeared first on The Motley Fool UK.

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Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.