Wednesday, December 16, 2009

Inflation Proof your income in retirement with Dividend Stocks

Build your own inflation proof source of income in retirement with dividend stocks

Investors who are worried about inflation but want to protect their principal are often told to invest in Treasury Inflation Protected Securities, which are indexed for inflation. In other words, investors yield and principal are indexed to the CPI and adjusted as the CPI rises over time. This sounds like the perfect deal of a lifetime, except for two caveats.

First, the yields on short and medium term and even longer term TIPs (TIP) have been very low as of recently, indicating that any income growth would be derived solely from inflation. Second, some investors are afraid that the CPI number does not account for the actual inflation. Even a small difference of 1% annually compounded over a long period of time would make a difference in your retirement budget. There is also the factor that the basket of goods and services, which are used to calculate it, is different than the basket of goods and services that an individual investor uses.
So how can investors create an inflation proof source of income in retirement?

A very good solution is to create a diversified portfolio of at least 30 stocks, purchased over time. Try not to overpay for them, and make sure that they are in a market where earnings growth could be achieved. Without earnings growth, dividend growth is impossible to achieve for any sustainable period.

An investor whose main expense items are utilities, fast food, groceries, cigarettes and liquor as well as personal care items could build their own inflation proof source of income in retirement with the following dividend stocks:

Consolidated Edison, Inc.(ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States. For example lets look at an investor whose monthly electric expense is about $100/month. They could purchase $20,000 worth of a basket of utilities stocks with long history of consistent dividend increases that yield 6%, in order to generate enough dividend income to never have to worry about this particular bill again. Con Edison is just one stock that could fit the characteristic. (analysis)

AT&T Inc. (T) operates as a communications holding company. Its subsidiaries and affiliates provide the AT&T brand services in the United States and internationally. What's better than having your landline or cellphone bill paid directly from your telecom company? If you spend $40/month on telecom services, you would need to invest approximately $8,000 in AT&T (T) stock. (analysis)

McDonald's Corporation (MCD), together with its subsidiaries, franchises and operates McDonald's restaurants in the food service industry worldwide. A $10,000 investment in McDonald's could provide enough income to purchase to purchase at least one big mac meal every week. (analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. By purchasing enough Wal-Mart stock, dividend investors could receive sufficient income to pay at least a portion of their grocery expenses. (analysis)

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in the United States and internationally. By investing in Altria, investors could essentially pay for their tobacco expenses. (analysis)

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. Exposure to real estate would help investors hedge their rent expense. (analysis)

If you would like to have your consumer products "for free" you could invest in consumer prodcuts giants Johnson & Johnson (JNJ) and Procter & Gamble (PG). Johnson & Johnson engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Check my analysis of this dividend aristocrat. The Procter & Gamble Company on the other hand engages in the manufacture and sale of consumer goods worldwide. The company has raised dividends every year for over half a century. (analysis)

In order to generate enough to pay for your gas expenses, a dividend investor might consider investing in one of the oil majors such as Exxon Mobil (XOM) or Chevron Texaco (CVX). Thus this investor would have the dividends received from these companies essentially pay for his or her annual gas expenses.

This article should really get you thinking not only about generating sufficient inflation adjusted income stream in retirement, but also about cutting unnecessary costs to the bone. Most novice dividend investors believe that simply purchasing the highest yielding stocks would do the trick of generating a sufficient dividend income stream for the next 3-4 decades. If a company is already paying most of its earnings out as dividends, chances are its ability to reinvest in the growth of the business are extremely strained. Because of the low growth expectations the market could assign a high current yield to this stock. Thus, an investor relying on this dividend stock might realize that it has failed to keep up with inflation and that he would have to downgrade his lifestyle.

Full Disclosure: I have positions in all stocks mentioned above

Relevant Articles:

- The case for dividend investing in retirement
- Utility dividends for current income
- The Sweet Spot of Dividend Investing
- Dividends Stocks versus Fixed Income

5 comments:

  1. There's a poster on one of the Morningstar discussion forums who implements this exact strategy. He tailors it to his particular utility company, phone carrier, and the like. It's a very practical way to capitalize on a dividend growth strategy, especially for a retiree (you're right about the CPI.)

    Thanks for a thought-provoking post.

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  2. I agree - great post. A very creative and pragmatic illustration of the power of dividend investing in high quality companies.

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  3. Don't forget Colgate Palmolive (CL)

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  4. This was a great entry DGI and a different angle then I had thought on how dividends protect against inflation. As inflation sets in and prices go up these companies will be receiving more money for their products and services and thusly a solid dividend company will pass that increase on to the investor.

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  5. I'm not sure I follow, and it might be my lack of experience. Are you assuming that the stock growth, over time, will offset inflation? Over the past 30 years, inflation has averaged 4.3% (see www.inflationdata.com). If you have a dividend portfolio yielding 4-5% per year, how do you ever outpace inflation without relying on market growth? Or do you assume that your principal will rise, as these companies are stable to begin with?

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