Why You Need Dividend Growth To Beat Inflation
I recently had a conversation with a gentleman who really “gets” dividend investing and he provided me with a synopsis of what is going on on a macroscopic scale in the world today. He came up with a “fictitious” conversation that will hopefully make sense to you all. Maybe it will even assist you in determining that you should buy dividend stocks now?
A General Overview
The central banks around the world are dealing with a liquidity crisis by lowering interest rates or injecting money into the financial system.
The Fed has been the most aggressive in cutting rates and injecting dollars into the system, causing the U.S. dollar to fall.
To the U.S., this means that its exports become cheaper and imports become more expensive.
While the world is fighting a credit crunch, inflation is creeping higher. Over time, as the cost of goods and services increase, the value of the dollar is going to fall because people won’t be able to purchase as much with their dollars as they did previously.
The Conversation
(PS - I live in Canada,so the gas price is in liters or litres :))“Wait a minute,” Bob said. “I recently read that both Canada’s and the U.S. CPI (consumer price index) is roughly two per cent.”
“You’re partially right,” I replied. “Core inflation is roughly two per cent, but it excludes certain items that are considered too volatile, including food and energy.”
“How can that be?” Bob asked. “Eve (Bob’s wife) told me eggs have jumped 62 per cent in price over the last two years and our food bill has increased more than four per cent over the last year.
“If memory serves me correctly, it cost 94 cents a litre to fill up my car last year.
“Now I am paying $1.18 per litre. If my math is correct, that’s roughly a 25 percent increase,” Bob said.
“Including food and energy, inflation in North America is running closer to four per cent,” I said.
“If oil and food commodities keep rising, then higher inflation and eventually rising interest rates will eventually follow. This is one reason why European countries are reluctant to cut their bank rates.”
A recent report from Bloomberg indicated that CPI in Ukraine was running at 19.4 per cent, in Vietnam it stood at 14.1 per cent, Russia was 12.6 per cent. Inflation in India is at 5.1 per cent and in China currently stands at 6.5 per cent.
These numbers are rising, not declining and there has been social unrest throughout the world because of rising food costs, even in some of the oil exporting nations.
“So what your are saying is that this sub-prime mess is temporarily forcing the central banks to reduce interest rates to help the economy get through this slowdown and credit crisis,” Bob said.
“But eventually, if food and oil costs remain high or continue to rise, interest rates will eventually follow suit.”
What this Means For Investors
(Hint: Buy Dividend Stocks)
As a result, the biggest dilemma savers face today is that at four per cent guaranteed investment rates on products, like GICs, they are only breaking even.
When you include income tax, these savers are likely losing money.
But an equity investor can invest in companies providing a four-per-cent dividend that also have growth potential at, or greater than, the rate of inflation.
So if inflation does rear its ugly head, ultra-conservative savers will be hurt, while with increasing dividends, equity investors will, at least, keep pace with inflation.
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