Inflation is the rise of the costs of goods and services in the economy. As things become more expensive, the purchasing power of money declines. For an investment to maintain its purchasing power, it must grow or provide an income stream that out paces inflation. Dividend paying stocks provide such an inflation hedge.
Bonds vs. Stocks
Investors looking for an investment that also provides income can choose between bonds and dividend stocks. A bond pays a fixed rate of interest, and bond interest does not index for inflation. So if a bond pays $5,000 a year in interest, that $5,000 will not buy as much 10 or 20 years in the future. Many dividend paying stocks increase the dividend payout as the profits of the company behind the stock grow. A portfolio of selected dividend paying stocks should provide a rising stream of income.
Dividend Yield vs. Inflation
An investor can select dividend stocks with yields greater than the rate of inflation to generate inflation beating income. At the time of publication, the Bureau of Labor Statistics reported inflation over the previous year of 3.6 percent. Factoring in a 15 percent tax on qualified dividends, a stock screen shows more than 500 stocks with dividend yields greater than 4.25 percent. The dividends from stocks selected from this list would beat inflation, even after taxes.
Dividend Growth Stocks
Many companies have a history of increasing their dividend payouts. The list of Dividend Aristocrats from the S&P 500 is approximately 40 companies that have increased their dividends for at least 25 consecutive years. The number of companies that have increased dividends for at least 10 years is close to 200. The typical rate of dividend increase is in line with the rate of profit increase.
Historical Dividend Growth
Standard & Poor's calculates the dividend amount each year for the S&P 500 index. Not all of the stocks in the S&P 500 index pay dividends, however, most do make distributions. Currently 390 of the 500 stocks in the index paid dividends. At the start of 1980, the dividend amount on the S&P 500 was $1.49. By 1990 it had increased to $2.86. At the start of the year 2000, the S&P 500 dividend had grown to $4.05, and as of the end of 2010, the dividend for the index was at $6.03 per year. These dividend increases show how dividend investing can keep up with, and even outpace inflation.
- Jupiterimages/Photos.com/Getty Images