With gasoline running around $3.30 a gallon, it costs each of us about three times as much to drive to work today as it did a few years ago. The same trip down the same road in the same car -- triple the pain to the pocketbook. Ouch.
There is a lesson to investors from all this pain, though. Merely keeping your cash is not enough. What you need to worry about isn't preserving your principal, it's preserving your purchasing power. Frankly, money manager Ron Muhlenkamp hit the nail square on the head when he defined risk as "the probability of losing purchasing power."
Beware the Jabberwock
That nasty beast called inflation eats away at the value of the cash in your bank account, every single day. On a short-term basis, it may seem manageable. In time scales measured in years, though, it gets downright nasty.
The important thing to understand about inflation, though, is that the extra money you spend to buy stuff doesn't just disappear even though it leaves your pocket. Instead, it keeps circulating through the economy. The people you paid an inflated price to buy from pay their suppliers an inflated price, too -- and so on, all the way back down the value chain. Because that money is still around, your goal as an investor should be to capture some of it back in order to stay ahead of the inflation monster.
The easiest way to do that is to own the right kind of stocks -- dividend-paying ones. This is a primary reason why at Motley Fool Income Investor, we focus on regular stocks that generate income, rather than bonds or preferred shares.
Show me the money
Here's where dividends become so important. Most mature dividend-paying companies base their payments on their earnings levels. Real estate investment trusts (REITs), for instance, are required to pay out at least 90% of their qualifying earnings as dividends to maintain their tax-advantaged status. Others are aware of the tremendous market signal their dividends project and therefore strive to keep a consistent payout ratio. Whatever the rationale behind the decision to boost their dividends, rising profits give room for companies to do just that.
What this means to you is simple: If you own shares of the right dividend-paying companies, then you can expect those dividends to grow at least fast enough to maintain their purchasing power -- if not faster. In fact, here are a handful of companies with both a decent current yield and a significant dividend hike in the past year:
|
Company |
Recent |
Dividend growth |
|---|---|---|
|
Wachovia (NYSE:WB) |
4.0% |
9.8% |
|
Citigroup (NYSE:C) |
4.1% |
10.2% |
|
CBL & Associates (NYSE:CBL) |
4.3% |
10.3% |
|
Entertainment Properties (NYSE:EPR) |
4.8% |
10.5% |
|
Plains All American Pipeline (NYSE:PAA) |
5.4% |
16.3% |
|
Reynolds American (NYSE:RAI) |
4.8% |
20.0% |
|
Pfizer (NYSE:PFE) |
4.4% |
20.8% |
What this means to you
If you needed your dividends for spending cash, your purchasing power would still be protected from the ravages of inflation. And if you didn't need to spend the cash right away, then it simply becomes additional money to help you build your inflation-resistant nest egg for the future. You can't keep inflation from happening, but you can help protect your pocketbook from its worst effects.
To get started preserving your purchasing power, click here to join us at Income Investor. In spite of the overall inflation rate, your 30-day trial is still free.
At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Pfizer is a Motley Fool Inside Value recommendation. The Fool has a disclosure policy.
