A 50% Crash Could Actually Make You Richer

What if your preferred stocks fell 50% and never recovered?

For most investors, that sounds like a nightmare scenario.

Imagine buying a preferred stock at $25 and watching it fall to $12.50. Your portfolio statement would show a 50% loss, and if inflation were simultaneously running high, the real value of your investment would be falling as well.

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This is exactly the type of scenario that has some income investors questioning whether they should abandon fixed income altogether.

But there is an important distinction that often gets overlooked:

A decline in the market price of an income investment is not necessarily the same thing as a decline in the income it produces.

If the underlying security continues paying its $2.50 annual dividend, a $25 preferred stock continues generating $2.50 of income whether the market values it at $25, $20, or $12.50.

And if you are reinvesting part of that income, a permanently lower price can actually become an advantage.

That sounds backwards.

Let's walk through the math.

The Real Risk Isn't Always Price

There are two very different risks facing an income investor.

The first is price risk.

Your preferred stock, bond, or other income security falls in market value.

The second is cash-flow risk.

The issuer cuts the dividend, stops paying, defaults, or otherwise damages the income stream.

These risks are often lumped together, but they shouldn't be.

If you own a bond that trades below par but continues paying its contractual interest and eventually matures at par, the temporary market-price decline is mostly an issue of mark-to-market volatility.

Preferred stocks are more complicated because many are perpetual securities. There may be no maturity date forcing the issuer to redeem your shares at $25.

That means a preferred trading at $12.50 could potentially remain at $12.50 for years.

For an investor focused on market value, that's a major problem.

For an investor focused primarily on cash flow, the picture can be very different.

Consider a 10% (Coupon) Preferred Stock

Suppose you own 100 shares of a preferred stock with:

• $25 par value

• 10% coupon

• $2.50 annual dividend per share

• 100 shares

• $250 of annual dividend income

In Scenario A, the price remains the same, and in Scenario B, the price drops by 50%, to $12.5/share.

When the stock price drops 50%, your 100 shares are worth only $1,250, and that looks terrible.

But your annual dividend is still $250. You haven't lost half your income. You have lost half your market value.

Those are not the same thing.

What If the Price Never Recovers?

Let's assume the price stays at $12.50 for 10 years.

You continue receiving $250 per year from your original shares.

But instead of spending all of it, you withdraw 75% and reinvest 25%.

Because the preferred still pays $2.50 per share, every new share purchased at $12.50 produces a 20% yield on the reinvested capital.

This creates a powerful compounding effect.

At $25, reinvested capital earns 10%

At $12.50, the exact same dividend produces a 20% yield on the new money.

And that is the key to understanding why a permanent price decline can eventually work in favor of an income investor.

The 25% Reinvestment Rule

At High Dividend Opportunities, our approach is built around the idea that income investors should reinvest a portion of the income to help preserve and grow purchasing power over time.

Let’s dive into our two scenarios with this reinvestment rule.

In Scenario 2, you end up with more shares because your reinvested dividends buy twice as many shares for the same amount of money. Your future dividend income grows much faster, and the difference becomes increasingly powerful as the years go by.

Then, Compounding Takes Over

Now extend the same hypothetical to 20 years.

The investor whose preferred stock was permanently cut in half now has ~7% more total wealth under these assumptions. And the advantage came almost entirely from one thing - reinvesting income at a higher yield.

The Longer the Price Stays Low, the More Powerful the Effect

Every year, the lower price allows more shares to be purchased.

Those additional shares generate additional dividends.

Those dividends purchase even more shares.

And the cycle continues.

In our simplified example, the lower-price scenario overtakes the higher-price scenario after roughly 18 years.

This produces a counterintuitive conclusion:

If the cash flow remains intact, a permanently depressed price can eventually be more beneficial to a long-term income investor than a permanently high price.

Why Income Investors Think Differently About a Crash

This is one of the biggest differences between an income-oriented strategy and a traditional total-return strategy.

Suppose you own a stock that falls 50%.

If the dividend also falls 50%, you have a serious problem.

If the dividend is eliminated entirely, you have an even bigger problem.

But suppose the price falls 50% while the income remains unchanged.

Suddenly, the investor has a different set of choices.

You can:

• Continue collecting the income.

• Reinvest a portion of it.

• Buy more shares at a higher yield.

• Allow your share count to compound.

• Wait for valuations to normalize.

• Or simply continue collecting cash if you don't need to reinvest.

The lower price is only harmful if you need to sell.

If you don't need to sell, the lower price can create an opportunity.

What About Inflation?

If deficits continue rising and governments respond to excessive debt through financial repression, monetary expansion, or policies that allow inflation to remain elevated, fixed coupons can lose purchasing power.

This is a legitimate concern.

A $2.5 dividend today does not buy what $2.5 bought 10 or 20 years ago.

But that doesn't mean the answer is automatically to abandon income investments.

Instead, the income investor needs to think about what happens to the cash flow and what happens to reinvestment yields.

If inflation causes interest rates and market yields to rise, the market price of existing fixed-rate securities can decline.

The Federal Reserve just raised interest rates by 25 bps. This means, new money can potentially be invested at higher yields, naturally combating the effects of inflation. Investors who continuously add capital through reinvested income.

At HDO, we are exploring several new issues that sport large starting yields. We also hold several picks that pay variable dividends, depending on market rates. Thanks to the Federal Reserve and the bond markets, our income is growing from both these investment classes.

But There Is an Important Catch

A falling price is not automatically good. The strategy we discussed only works if the underlying cash flow remains sufficiently intact.

If a preferred stock falls from $25 to $12.50 because the issuer is in financial distress and ultimately cuts or eliminates the dividend, the risk profile changes completely. Simply buying more at a lower price does not magically make it a better investment.

The ideal scenario for an income investor is high-quality income securities become temporarily or permanently cheaper while their underlying cash flows remain durable.

For example, preferred securities issued by some of the largest banks in the United States, currently trade at a ~40% discount to their liquidation preference. Rising interest rates weigh in on their market price, but have no effect on their dividend payments. At HDO, we are buyers of some notable picks like:

• Capital One Financial 4.25% Perpetual Preferred Stock (COF-N) – Yield 7%

• Synchrony Financial 5.625% Perpetual Preferred Stock (SYF.PR.A) – Yield 7.5% 

There are also investment-grade preferred issuances from Tier 1 Banks offering deep bargains and +6% yields.

Look beyond price, look at the quality.

The Real Enemy Is Selling at the Bottom

A 50% decline in an income portfolio feels devastating because investors have a natural tendency to focus on the account balance. But if the securities continue producing the same income, the investor's economic situation may be much better than the account statement suggests. The greatest danger is turning an unrealized decline into a permanent loss by selling solely because the price has fallen.

If you panic and sell that 50% loss is real. You no longer own the security, and are no longer entitled to receive the dividend. You also no longer participate if the security eventually recovers. But if the security remains fundamentally sound, continuing to collect the income gives you something extremely valuable - Time

Time allows compounding to do its magic.

"Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it." – Albert Einstein

Don't Fear the Price — Protect the Income

Government debt, inflation, and rising interest rates are legitimate risks for fixed-income investors. But abandoning fixed income simply because prices might fall could be the wrong conclusion. The more important question is - What happens to the cash flow?

A bond that declines in price but ultimately matures at par is different from a bond that defaults. Similarly, a preferred stock that falls 50% but continues paying its dividend is different from one that cuts the dividend.

The price matters. But for an income investor, the income matters more, and weak pricing can be an opportunity to accelerate the effects of compounding.

Our Income Strategy Is Built for This Environment

We don't build an income portfolio on the assumption that markets will always cooperate.

They won't.

There will be recessions. There will be inflation. Interest rates will rise and fall. Preferred stocks will trade below par. Bonds will experience periods of significant volatility. Occasionally, entire sectors will fall out of favor.

Our objective is to build a portfolio around durable income streams, diversify across different types of income-producing securities, and continuously put a portion of that income back to work.

That's why we don't view every price decline as a reason to run. Sometimes, the best thing an income investor can do when prices collapse is to keep collecting the income, keep reinvesting, and let compounding do the work.

Because if the income survives, the lower price isn't necessarily your enemy, it may be your biggest opportunity.