The Power To Beat Inflation
The object of a retirement plan must be to create a portfolio that will provide for a reliable retirement income for 20-to-35 years of retirement and even longer.
This income has to increase net of inflation—and minimize or eliminate the need to sell shares during down markets. With an adequate time horizon, a focus on stocks that consistently generate an increasing cash dividend payout in all market conditions has historically accomplished this objective.
Stocks that steadily increase their dividend payouts are also a natural hedge against inflation. They produce a liquid, cash income that increases every year by well in excess of the average historic inflation rate.
The historic U.S. inflation rate can vary quite a bit based on the time period you choose. Over the last decade, the average year-over-year inflation rate has been 1.52 percent. But this excludes the high-inflation 1970s, which could potentially return again. Since World War Two, the average overall U.S. inflation rate, year-over-year, has been 3.22 percent, as measured by the U.S. Consumer Price Index.
Under both scenarios, U.S. dividend-paying stocks have a long track record of outpacing the inflation in dividend income generation alone.
The Power To Beat Bonds
Because income from stock dividends tends to increase over time, over long holding periods, stocks tend to have a natural advantage over bonds when it comes to generating retirement income.
Income from a bond or fixed-income investment, with the exception of a few specialized securities like TIPS, is just that: fixed. Income will not increase to counter the effects of inflation. As long as investors hold the bond, the coupon rate is what they will get, regardless of any increase in the cost of living or the growth of the economy. And if interest rates fall and you have to reinvest, interest income could actually fall.
Dividend income, however, is not directly tied to interest rate risk. It’s more closely tied to the underlying fundamentals of the company.