How to beat inflation and grow your purchasing power

Retirees are often advised to avoid risk by buying government bonds and holding them to maturity. But this exposes retirees to the risk of losing purchasing power due to inflation. The Investment Reporter’s Key stocks that raise their dividends each year can offset this risk.

The usual advice to retirees is to buy ‘safe’ fixed-income investments. Those who give this advice argue that stocks expose retirees to excessive risk. They say government bonds held to maturity eliminate all risk. In our view, these advisors overlook a big risk facing retirees: the ongoing loss of purchasing power due to inflation.

This brings to mind the case of the mother of a friend. After the premature death of her husband in the early 1950s, our friend’s mother collected on his life insurance policy and was advised to avoid all risk and buy government bonds.

As inflation rose in the 1970s and 1980s, however, our friend’s mother found it harder and harder to make ends meet. Ultimately, our friend and her brother had to help support their impoverished mother. In the attempt to avoid all risk, our friend’s mother had underestimated the risk that rising prices posed to her standard of living.

A study found that inflation has averaged 3.1 per cent since 1926. This period included many changes: falling prices in the 1930s, government-controlled prices in World War II, low inflation in the 1950s and 1960s, rising and high inflation in the 1970s and 1980s and declining inflation since then. This period covered any conditions we’re likely to see in the future.

You’ll likely face inflation of 3.1 per cent

Inflation of 3.1 per cent will cut your purchasing power in half in 23 years. With longer life expectancy, many people these days live more than 23 years after retiring. And we expect inflation to rise in the years ahead (see below). This suggests you should take steps to protect yourself from inflation when you retire. Except for real-return bonds (which pay inflation-adjusted interest and principal), bonds offer you little protection.

Many of our Key stocks raise their dividends faster than inflation. Consider U.S. Key stock Procter & Gamble, or P&G. In 2006, it paid a dividend of $1.15 a share. But the company has raised its dividend for 60 years in a row! It now pays $2.68 a share. That means that P&G has raised its dividend at an average yearly compound growth rate of 8.83 per cent over the past decade. That’s far ahead of inflation, giving you growing purchasing power each year.

Stocks that can outpace inflation

Canadian Key stocks that have raised their dividends in each of the past five years include Agrium, Alimentation Couche-Tard, Atco, Bank of Montreal, BCE, CAE, CIBC, CN Railway, Canadian Tire, Canadian Utilities, CCL Industries, CI Financial, Emera, Enbridge, Finning International, Fortis, Gildan Activewear, Hardwoods Distribution, High Liner Foods, Imperial Oil, Jean Coutu Group, Loblaw Companies, Royal Bank, Metro, Open Text, Richelieu Hardware, Saputo, Scotiabank, Shawcor, Stella-Jones, Suncor Energy, Telus, Thomson Reuters, Toromont Industries, TD Bank, TransCanada, and Transcontinental.

Legendary investor Peter Lynch argues that dividends plus some capital gains can initially pay just as much as bonds. Then, within a few years, rising dividends will exceed the interest the investor would’ve earned from bonds.

In 2016, Canada’s inflation rate is expected to rise by 1.6 per cent. But some factors could push up inflation. One is loose fiscal policies that have put lots of money into the global economy.

Also, the baby-boom generation will spend more than it earns when it retires. Inflation became a problem in the 1970s and 1980s when then-young boomers spent more than they earned, borrowing money to buy bigger houses, more cars and so on. Rising demand by legions of retired boomers could raise prices.

Then, too, populous countries in Asia—especially China and India—are certain to need resources. This could force up resource prices.

You should protect your purchasing power by buying companies that regularly raise your dividends—even more so when you’re retired.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846