There has been a lot of noise recently that the market is overdue for a correction. Investors are thinking about going to cash or that maybe the bond market is not actually as overvalued as it looks. Well, this article offers a third path; riding out any short-term storms in low volatility stocks while still squirreling away a dividend for the long term.

The reasoning for wanting low volatility stocks when facing a potential downturn is obvious. They tend to go down less than the market, which means you lose less money. However, they tend to go up less than the market in good times, so you make less money. I would say you only actually make the money when you’re smart enough to sell; if the stock goes down again, you just have a nice story. This perceived lack of upside is what turns many investors against low volatility stocks.

However, you are not actually sacrificing long-term returns by purchasing low beta stocks. There is fairly clear historical evidence that low volatility stocks actually generate excess returns over pure index investing.

What we can see from this table is that low volatility stocks not only suffer less volatility than the index as a whole, they actually generate better returns than the index — 2% better in absolute terms, 3% in risk-adjusted terms (CAPM alpha). Yes, value stocks and momentum stocks do better in the long run, but we’re looking for low volatility here, so any bad times don’t hurt as much.

The low volatility portfolio in this study consisted of an equal weight of the 30% lowest volatility large stocks (the largest 50% by market cap). So, let’s start the screen there. I used the Google Finance screener for this, but there are many alternatives that may or may not be better.

There are 7415 stocks included in the screener for the United States. Setting a minimum market cap of above $420M gets us down to 3500, which is a nice round number. Looking for a beta between -0.5 and +0.5 leaves us with 1041 stocks, which is about the lowest 30% of that largest 50%.

If the stock is paying a dividend, that should give us a nice income even during the bad times. Asking for a 2% yield drops our stock universe to 262. That is much better, but still too many to look at individually.

This is where things get a little subjective, but we are looking for safety, so my next step was to look at total debt / equity. Setting that to 50% shareholder equity is at least twice total debt got us down to 128 companies. This should mean the company is in a stable financial position.

There are a lot of income / bond funds in this list at the moment. They are not quite what we’re looking for. They may be very good ways of getting bond exposure and avoiding market downturns, but we’re looking for actual businesses in this screen. So, if we set the 10 year EPS growth rate to 0.05% or higher, then we’re left with a much more promising list of just 20. Three income funds managed to slip through our net, so we have 17 companies to look at.

This is where we are at right now: