1 Big Dividend Stock to Protect You From an Inflationary Future

While inflation has been tame the past two decades, you unfortunately can't invest in the past (otherwise historians would be billionaires). With near-zero interest rates, a growing money supply, and politically unpalatable options to fix the growing national debt (just look at how well the Greek politicians are dealing with their debt), inflation -- a portfolio's silent killer -- is likely to rear its head again. The best way to protect your purchasing power is to own assets whose yields will grow with inflation, such as high-quality blue-chip stocks, REITs, and MLPs. I've already revealed my 3 Disaster-Proof Dividend Stocks and my High-Yield Divided Portfolio to Beat the Market (it is). Read along, and I'll explain why you should be concerned with inflation, how it will affect your portfolio, and I'll pick a stock to protect your assets from inflation.

The silent portfolio killer
While some argue that employed non-investors don't need to worry about inflation, it is a killer for those living off savings and fixed income. Year over year, the producer price index is up 7%, and the consumer price index is up 4%. These are clear indications of rising inflation.

Now some economists will say that core inflation -- which excludes food and energy -- is only 2%, but I have yet to meet a person who doesn't need food or energy. These rising prices eat into returns. For example, investors in 10-year Treasuries, currently yielding 2.125%, are losing purchasing power as they keep their money in them (or breaking even for those investors who don't eat).

Even for equity investors, though, inflation kills returns. As Warren Buffett explained in his 1977 Fortune article, "How Inflation Swindles the Equity Investor":

For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.

And why didn't it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.

Warren then goes on to argue that in aggregate, returns on equity, the "equity coupon," are relatively stable. Rising inflation eats into businesses returns, which leaves less returns for shareholders.

So what options do investors have?

  • Gold: When paper money is losing value because the government keeps printing it, people turn to gold because it holds its value. While ETFs like the SPDR Gold Trust (NYSE: GLD  ) are an option, resident metals expert Christopher Barker believes Primero Mining (NYSE: PPP  ) is the greatest gold stock in the world.
  • Real estate investment trusts: Real estate is a classic investment hedge as properties rise in value along with inflation. To be clear, I don't mean mortgage REITs such as American Capital Agency (Nasdaq: AGNC  ) , which would be hurt by rising interest rates that would likely go with rising inflation.
  • Treasury inflation-predicted securities: These U.S. bonds are like normal Treasury bonds; however, their value is adjusted upward in line with rising inflation. The problem with TIPS is that they are still bonds, and like normal bonds, they will do poorly if interest rates rise, which can happen with or without inflation.

With all that said, there is another way...

Oil products pipelines
Oil pipelines are regulated by the Federal Energy Regulatory Commission and have contracts that adjust for inflation annually. For the next five years, their contracts adjust at the rate of the producer price index for finished goods, +2.65%. The structure of their contracts should allow these companies' payouts to rise faster than the rate of inflation, no matter the rate.

The company I like best in this space is Magellan Midstream Partners (NYSE: MMP  ) . To be clear, Magellan is not a stock; it is a master limited partnership. As I've explained before, MLPs can be a great way for investors to earn income and pay less in taxes, but they may require significantly more tax hassles and shouldn't be held in IRAs. For a full explanation, check out this article.

Magellan operates one of the largest pipelines for refined petroleum products such as gasoline and heating oil. Of its contracts, 40% are subject to the indexing method, with the remaining 60% are adjusted at the company's discretion, though these rates track the regulated rates. In July, the company raised "virtually all" of its rates by 7%, consistent with FERC guidelines.

The company currently yields 5%, more than twice the yield of Treasuries. This yield, however, is better than Treasuries since it comes with the built-in inflation adjuster I mentioned above. There's even more to like -- the company has increased its distribution 37 times over the past 10 years at an 11% CAGR. It covers its distribution 1.2 times, meaning Magellan has some money left over to invest in new pipelines.

Foolish bottom line
With a 5% distribution, a very stable business, and built-in inflation protection, Magellan Midstream Partners is definitely worth a look, especially if you are worried about inflation.

Given the tax considerations of publicly traded partnerships, the units may not be for everyone. For those looking for dividends for their retirement accounts, I invite you to take a look at 11 other dividend stocks in a brand new free report from The Motley Fool called "11 Rock-Solid Dividend Stocks." To get instant access to the names of these 11 dividend stocks, click here -- it's free.

Dan Dzombak can be found on his Twitter account: @dandzombak. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Magellan Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (16) | Recommend This Article (60)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 02, 2011, at 5:31 PM, billfed1 wrote:

    Perhaps the author would expand on this sentence:

    "Given the tax considerations of publicly traded partnerships, the units may not be for everyone. "

  • Report this Comment On November 02, 2011, at 5:44 PM, xetn wrote:

    While gold stocks can certainly outperform the metal at times, there is nothing that protects you like the physical metal, because there is no counter-party risk.

  • Report this Comment On November 02, 2011, at 5:49 PM, TMFBreakerRob wrote:

    MLPs are among my favorite income investments, but the tax considerations are not suitable for a short article. I'd suggest a few things:

    * A brief overview

    * A darn good cheap book (real cheap on Kindle!)

    * Think it over. I find that it can be quite rewarding to hold them in my IRAs, but as your reading will reveal, you have to watch what you're buying to avoid UBTI issues. Digging up UBTI info can be done on a trial and error, do it yourself basis, or you can find a forum for such discussions.

    Sorry, no quickie simple answer here, but its hard to beat the rewards. It'll take solid study, but that book above is the best primer I've found.

  • Report this Comment On November 02, 2011, at 6:30 PM, eddiegorniakjr wrote:

    Is nly a stock that will go down when inflation starts going up. Or is it ok to hold onto it?

    Thank you.

  • Report this Comment On November 02, 2011, at 7:57 PM, kanawha40 wrote:

    I am not sure I agree with the comment about not holding in your IRA - I have 2 different MPL's of which this is one inside my IRA. It solves all of the complicated tax issues in my opinion. If I am missing something, please weigh in. Thanks

  • Report this Comment On November 02, 2011, at 8:40 PM, akakroke wrote:

    About the tax issue, if I have an accountant prepare my taxes (I do not do my own; don't have the brain power), should I expect him to be aware of what's involved and deal with it seamsly without bothering me?


  • Report this Comment On November 02, 2011, at 9:38 PM, TMFBreakerRob wrote:

    Re: MLP taxes

    MLPs in a taxable account usually result in the most tax complexity. Not only do you have a changing cost basis over time, but (depending on the size of your investment) you may have to file taxes in multiple states where the MLP does business. Due to these issues, I don't have MLPs in taxable accounts.

    In a non-taxable account, the only possible concern is if UTBI exceeds $1000 per year in any of your IRA accounts. Since all my MLPs generate negative UBTI, this is a moot point (for now). Its worth keeping tabs on, of course.

    Personally, if one is keeping MLPs in a taxable account and having somebody else prepare taxes, I'd want to have assurance that my CPA understood the ins and outs of MLPs. Its a relatively arcane investment vehicle and I wouldn't assume just any CPA was competent in this field. No offense intended toward any CPAs, just that I know that not all are experts in everything. My former CPA would be learning as he went along and that would be unacceptable to me.

    No, I'm not a CPA, but I've made it my business to know something about this because I've got skin in the game.

  • Report this Comment On November 03, 2011, at 5:52 AM, CNINT1 wrote:

    I am a foreign investor. Does an investment in MLP's subject me to US taxation, other than withholding tax ? Who knows it ?

  • Report this Comment On November 03, 2011, at 8:04 AM, ALLWIN wrote:

    Dan, in your article you stated:- "To be clear, I don't mean mortgage REITs such as American Capital Agency (Nasdaq: AGNC ) , which would be hurt by rising interest rates that would likely go with rising inflation."

    Can you tell us which REIT's are the preferred ones for investors are seeking protection from an "Inflationary Future".

    Looking forward to your response, much thanks.

  • Report this Comment On November 03, 2011, at 1:07 PM, DJDynamicNC wrote:

    "When paper money is losing value because the government keeps printing it, people turn to gold because it holds its value."

    Dollars fluctuate in value because they are only worth what people are willing to give you for them. Gold on the other hand, is worth... whatever people are willing to give you for it.

    I don't see this as much of a hedge. You could say "historically, gold prices always go up." But then, you could have said that about housing a few years ago, too....

  • Report this Comment On November 03, 2011, at 2:54 PM, TMFDarwood11 wrote:

    I think I would be better served buying something like SDY, which has/had a 12 month yield of 3.26% with none of the tax headaches and is somewhat diversified.

    I can also buy some DVY if I want a bit more juice and a bit more risk.

    True, I won't get that fat 5% dividend. But there is risk in buying any single stock or MLP.

  • Report this Comment On November 03, 2011, at 3:19 PM, Merton123 wrote:

    Gold and Silver - what is the intrinsic value? What are jewelers substituting for gold? Whatever is the price of the substitute is the real cieling price for gold based on industry demand. I like the article written today - good for a retiree. Income that is stable and will keep pace with inflation. Gives a lot more then a CD.

  • Report this Comment On November 03, 2011, at 5:06 PM, whyaduck1128 wrote:

    I'm a tax guy, and I have a problem with all MLPs. The problem is that the "yield" you're getting may be a return of your own money. The cash you get is a distribution, not necessarily net income; the latter must be computed at the end of the year, using information from the partnership (either on a K-1 or in booklet form). The net income is added to your basis or net loss subtracted, and the distributions are subtracted. Your basis changes every time you get a distribution and at the end of the year (or year-to-date if you sell).

    From a tax viewpoint, MLPs are messy, complicated, often a pain even for those who do returns for a living, and sometimes impossible to explain. Also, they're a favorite of brokerages to sell to widows and such because of the superficially high yield.

  • Report this Comment On November 03, 2011, at 9:57 PM, UFOFred wrote:

    What does a Master Limited Partnership have to do with University of Toronto Business Intelligence?

    Seriously, please define your acronyms.

    From the founder and chief pooh bah of CRAP, the Coalition for the Reduction of Acronym Proliferation.

  • Report this Comment On November 10, 2011, at 4:33 PM, ALLWIN wrote:

    CNINT1 wrote:

    I am a foreign investor. Does an investment in MLP's subject me to US taxation, other than withholding tax ? Who knows it ?

    I don't but have a read of the article at link below.

    Best wishes

  • Report this Comment On November 11, 2011, at 6:37 PM, newageinvestor wrote:

    Why does NLY always evoke fear of inflation around here? The Fed is not going to raise interest rates any time soon and if the stock can hold its value in this economy AND return that dividend people shouldn't be afraid of it just because of this constantly nebulous fear of inflation.

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