Inflation is on many people’s minds, and there’s valid cause for concern as inflation was up 2.6 percent over the previous 12 months in May.
So far, consumers have dealt with higher prices on everything from cars to medical care, food, and cigarettes, as demand has not faltered in the face of higher prices. Many economists attribute this to stimulus checks that have pumped the economy with trillions of dollars. These same economists see inflation coming home to roost once the stimulus money runs dry.
Fixed-income assets like dividend stocks have often been touted as the ideal antidotes to inflation. The truth is dividend stocks are overrated in an inflationary environment – or any environment for that matter.
Dividend stocks are overrated in two ways:
- Their returns are not great, to begin with.
- They are not guaranteed in a downturn.
Why aren’t dividend returns great, to begin with?
Well, in the last 20 years, the average dividend yield of the S&P 500 hovered around 2%. With inflation just heating up at 2.6%, which amounts to an average annual loss of 0.6% from S&P 500 dividend stocks, imagine how ineffective these dividend stocks will be when inflation hits 3%, 4%, and so on.
As discussed above, dividend returns aren’t exactly effective against inflation, but that’s assuming they’re even paid during an inflation-fueled downturn. How does inflation fuel a slow down? It all begins and ends with the Fed.
Historically, the Fed has responded to inflation by increasing interest rates, which increases the cost of borrowing by businesses, which slows production and results in reduced sales and diminished bottom lines. This all leads to a bear market as stocks dive on plummeting bottom lines, which brings me back to dividends. Dividends are not guaranteed. The Great Recession exposed this reality as many companies either suspended or reduced their dividends in the face of a market downturn.
Dividend stocks are overrated. They are neither a great buffer against inflation – as the returns from most dividend stocks fail to keep pace with inflation – or even a guaranteed source of income in a downturn. Many companies have been known to suspend their dividends altogether during recessions.
If not dividend stocks, then what is an ideal asset for countering the effects of inflation? Preferably an asset with a demand that doesn’t waver in the face of inflation.
As prices rise, consumers start prioritizing their buying choices. The first to go are luxuries. Instead of buying new cars, consumers drive and fix what they have. Clothes from Target replace clothes from Macy’s, and the list goes on. Consumers prioritize their money towards essentials like shelter, fuel, and clothing.
As for assets with a demand that won’t waver in the face of inflation, think of all the Baby Boomers who will get older in the coming decade and will require shelter with some kind of assisted living. This number is not expected to shrink anytime soon as the number of aging adults relative to other segments of the population will be staggering, so much so that by 2030 the number of older Americans will outnumber children for the first time in U.S. history.
Some investors make the mistake of jumping out of the fryer directly into the fire when the heat starts rising.
When the heat inflation starts rising, don’t make the mistake of diving into dividend stocks. Invest in something that will keep pace with inflation, like certain real estate segments like residential assisted living where rising prices shouldn’t affect demand.
The U.S. population is only getting older, and this population will only continue to need care and assistance. Investing in demand is the way out of inflation.
Will the assets in your portfolio maintain demand in the face of inflation? If not, it’s time to reassess and reallocate to assets that do.