Stop blindly trusting traditional dividend stocks. Learn the 3 golden rules of true defensive stocks to protect your FIRE portfolio during a recession.
Introduction
When rumors of an economic recession start spreading, beginners usually get the exact same advice: “Just buy safe dividend stocks!” It is a comforting thought. But if you want to successfully navigate your Easy FIRE Plan, you need to know a harsh truth.
A stock is not automatically safe just because it pays a dividend. Today, we will learn why you should not blindly trust traditional dividend stocks, why mega-insurance companies are currently a great example of safety, and how you can use 3 golden rules to find true defensive stocks in any industry.
Why Traditional Dividend Stocks Are Failing Us
In the past, investors believed that the Utility (electricity and water), Consumer Staples (food and drinks), and Healthcare sectors were perfectly safe. The logic was that people must use electricity and buy medicine even if they lose their jobs.
But the world has changed drastically in the 2020s. First, we live in a high-interest-rate environment. When safe government bonds pay a 5% return, getting a 2% or 3% dividend from a slow-growing consumer staple company is no longer attractive.
Second, heavy government regulations are eating their profits. Governments are forcing utility companies to spend billions on green energy, and pressuring healthcare companies to lower their drug prices. When their profits are restricted, their dividends are no longer perfectly safe.
The Mega-Insurance Example
If traditional sectors are struggling, where should we look? A great example of a modern safe haven is the Mega-Insurance and Reinsurance sector.
Unlike traditional dividend stocks, insurance companies actually benefit from a recession and high interest rates. People almost never cancel their auto, home, or health insurance during an economic downturn because they are terrified of bigger risks.
More importantly, insurance companies do not just lock your monthly premiums in a safe. They invest that massive pile of cash into bonds. Because interest rates are so high right now, these companies are earning massive amounts of free “investment income” just by holding cash.
The 3 Golden Rules of a True Defensive Stock
You do not have to only invest in insurance companies. As intelligent investors, we can apply the logic of the insurance industry to evaluate any new industry. If you want to find a true defensive stock that will protect your money, check if the business meets these 3 Golden Rules:
- High Cash Flow & Benefits from High Interest Rates: Does the business model naturally hold a lot of cash? Will the company make more money from interest when bank rates go up, rather than suffering from expensive debt?
- Pricing Power Without Government Interference: Can the company easily raise its prices without the government trying to stop it? For example, specialized cyber-insurance companies can raise their premiums by 20% to 40% a year because they are not heavily regulated like basic utilities.
- Irreplaceable B2B (Business-to-Business) Services: General consumers might stop buying expensive coffee during a recession. But big corporations cannot stop paying for essential services that prevent them from going bankrupt, like cybersecurity against hackers. Look for companies that provide services other businesses cannot survive without.
Conclusion
Do not just trust a “dividend” tag. To protect your money and reach financial freedom, you must look at how the actual business model survives in the real world. Keep these 3 golden rules in mind the next time you analyze a new stock!
Invest simply. Retire early. Enjoy life sooner. Which industry do you think perfectly fits these 3 golden rules today? Let me know your brilliant ideas in the comments below!