Is DGI the Perfect Answer to Inflation?

24 Jan 2015 14:48

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Finding an investment product that can provide an income and at the same time continually rise to exceed the inflation rate is a primary goal for many retirees or soon to be retirees.

Finding such a vehicle is a daunting task. Fixed Income (bonds, preferred stock & fixed annuities) while low risk, operates just as it names describes. They provide a fixed income over time with no increases. It is predictable but cannot combat inflation.

Investing in stocks on the other hand does have the potential to grow and beat inflation. In the world of stocks, the dividend growth investing (DGI) strategy claims that a stock that continually grows their dividend is a sound hedge against inflation. But is this really the case? To prove this theory I analyzed a small basket of DG stocks that have been paying dividends for 25 or more years:

  • Aflac (AFL)
  • AT&T (T)
  • Coca-Cola (KO)
  • Emerson Electric (EMR)
  • ExxonMobil (XOM)
  • Johnson & Johnson (JNJ)
  • Leggett & Platt (LEG)
  • McDonalds (MCD)
  • Procter & Gamble (PG)
  • Wal-Mart (WMT)

Note: Considered posting graphs for all stocks but that would have made this post pretty busy so instead contrasting graphs of PG & WMT will be used. If anyone would like the data for the other stocks leave a post and it will be provided.

Of all the stocks, only WMT has consistently increased annual dividends at a rate that beat inflation. This is rather surprising as they are so closely tied to the economy. Other than WMT, each position failed to increase their dividend that exceeded the inflation for at least one year. The primary data points discovered were:

Average Inflation non-beat; once every 8 years (7.88 yrs to be exact)
Average dividend growth to inflation rate growth during the non-beat; -5%


While not perfect, DGI is pretty darn effective! Though one could argue that the years that they did beat inflation, the dividend growth exceeded the inflation rate by such a large amount that it compensates for any one-time loses giving your long term growth rate a positive factor and this is a sound statement.

But, what if your income did not meet or was just meeting your expenses at the start of retirement? You may have been planning on that growth from the start and the years you do not beat inflation could hurt. With people living longer it is not unreasonable to assume a 30 year retirement of which there will be 3 times during that period where income growth will fail to beat the inflation rate.

While DGI is extremely effective it is not a 100% solution. Question now is; are their alternatives that can reduce the risk?

Diversify with Real Estate Investment Trusts

REITS tend to be influenced by different factors than the overall market and has growth at different cycles. In theory this should also apply to their dividend growth. To confirm this I analyzed:

  • Realty Income Corp (O)
  • HCP Inc (HCP)

The two REITs dividend growth also failed beat inflation once every 8 years but that 8 year cycle was completely different. When our basket of stocks failed to match the inflation rate REITs beat it and vice-versa.

Another factor discovered is the amount they failed to beat the inflation rate was much lower on average; -1.3% versus -5% for our basket of stocks.

By diversifying with REITs we reduce risk and spread losses out over different years leading to the conclusion that some REIT positions are necessary components for DGI.

Are there other alternatives? Most likely…wish to share? I'm willing to listen & learn.

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