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Introducing the Inflation-Protected Income Growth Portfolio

By Chuck Saletta - Dec 4, 2012 at 11:13AM

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A real-money portfolio based on the principle that companies that pay and regularly raise their dividends provide the best available defense against the long-term ravages of inflation.

No matter how you handle your money, you're putting it at risk. For instance, consider savings accounts and U.S. Treasury bonds, which carry government guarantees that you'll get your principal back. You may very well get every dime back, but unless the interest rates you get cover inflation and taxes, those future dimes may spend more like today's nickels and pennies once your money gets returned to you.

In a world like today's where there are no real safe havens, the best you can do is pick the risks you'd like to combat and invest with a strategy designed to address them. Over the long haul, one of the biggest risks you'll face is inflation, whose continual erosion of your purchasing power makes it tougher to make ends meet very single year.

Beat back that ugly demon
Among the best inflation fighters out there comes in the form of plain old ordinary common stock. But not just any stock will do -- the true inflation fighters are ones that:

  • Pay dividends
  • Have regularly increased their dividends
  • Look capable of continuing to increase those dividends
  • Are reasonably priced in the market
  • Have the financial strength to persevere, even during rough economic conditions

Not many companies fit the bill, but there are a fair number available. Even better, there are examples of such stalwarts across multiple industries, making it possible to build a fairly well diversified portfolio around them.

Real money against a real risk
That's the goal of the Inflation-Protected Income Growth -- or iPIG -- portfolio. It's a real-money portfolio designed to throw off an income stream that increases each year as a bulwark against inflation. I'm launching the portfolio today with $30,000, and managing it online here at The Motley Fool. Even better, I'll be letting you know in advance of what I'm looking to buy and at what price I'd be willing to buy it.

To make the cut, each individual selection will need to provide:

  • An established track record of paying and raising its dividends
  • A reason to believe that track record will continue
  • A healthy enough balance sheet so that ordinary economic rough spots shouldn't derail it
  • A price tag justified by some fundamental valuation method
  • A decent fit from a diversification perspective

When it's completely built, the portfolio will hold in the neighborhood of 20 stocks, with each investment targeted for somewhere between $1,000 and $3,000. New money may be added from time to time, and dividends will be collected as cash, with the intent to invest them in a future pick. Stocks can be sold from the portfolio as conditions warrant, but the hope is that by being so choosy on the buy side, churn can be minimized.

Why this works
When a company like Coca-Cola (KO 1.88%) strings together a 50-year history of raising its dividends to go along with a better than 90-year track record of paying them, that's no accident. That's the power of a solid balance sheet, a business plan built around the long haul, and the dedication to consistently reward investors directly for the risk they're taking by owning the stock.

Over time, owning companies like that can create millionaires from ordinary people. Just look at the story of Grace Groner, who turned a $180 investment in Abbot Labs (ABT 3.05%) into a multimillion-dollar estate over the course of an investing lifetime. Abbot itself has a 40-year history of raising its dividends and is also closing in on 90 years of paying them, which puts it in rarefied company with the likes of Coca-Cola.

Additionally, dividends are incredible signaling devices that often communicate far more clearly than management does about a company's prospects. For instance, when General Electric (GE 4.70%) got into financial trouble for its role in the subprime mortgage mess, it held its dividend steady for six quarters before finally slashing it. After decades of routinely raising its payment annually, that change in behavior provided a clear signal -- and advance warning -- of just how much trouble the company was in.

On a related note, it's for reasons just like the subprime mess that damaged so many financial institutions that diversification will play an important part of the portfolio. Once seemingly insurmountable titans like Citigroup (C 3.26%) and JP Morgan (JPM 2.98%) were forced to slash their dividends to recover from the crisis. Even today, only the strongest of the surviving banks have been able to reinstate their payments.

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Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
$47.86 (3.26%) $1.51
General Electric Company Stock Quote
General Electric Company
$67.08 (4.70%) $3.01
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$117.32 (2.98%) $3.40
The Coca-Cola Company Stock Quote
The Coca-Cola Company
$63.04 (1.88%) $1.16
Abbott Laboratories Stock Quote
Abbott Laboratories
$109.45 (3.05%) $3.24

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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