Dividend stocks can be an investor’s best defence in the battle against inflation.
Consumer price inflation in the UK is rising at double-digit percentages. So the sub-2% interest rates that most savings accounts currently offer aren’t going to make much of an impact, even though those rates are guaranteed.
This is why I prefer to use any spare cash I have to buy UK shares. And right now I’m concentrating on buying big-yielding dividend stocks that can help counter the impact out of runaway inflation on my wealth.
As Mark Peden, manager of the Aegon Global Equity Income fund, said: “Dividends have a good track record of keeping pace with inflation.”
Risky business
It’s said that investing in stocks is more risky than parking my cash in something like a savings account.
If I invest £10,000 in the stock market I might lose some or all of it. The shares I buy could slump in value or go out of business altogether.
By comparison, if I park £10k in a savings account I know that my money is protected. Even if the bank goes out of business I can get it back through the Financial Services Compensation Scheme. I’d have also made a little interest on my capital in that time.
Cash dangers
But this is a rather simplistic way to look at things in a period of high inflation. Indeed, using a low-yielding cash account in times of high inflation also poses considerable risks to my wealth.
Let’s say I park that £10,000 in an account with a 1.5% interest rate. And let’s say that inflation continues to run at around 10% for the next year.
By this time in 2023, I’ll have £10,150 in savings. But that double-digit inflation means I’d need £11,000 to retain the same purchasing power as today. I would have effectively lost money.
Protecting my wealth
Buying dividend stocks can help narrow the difference. This is because the average dividend yield on UK shares sits at just below 4% right now. This is more than twice the interest rate on most savings account.
Of course dividend yield forecasts are simply based on City estimates. The level of the actual payout can come in less than expected. But I can minimise this risk by seeking income stocks with healthy balance sheets, strong dividend cover and defensive operations (like utilities, telecoms and healthcare providers).
Beating inflation
With some careful research I can find top dividend stocks whose yields beat that 4% average too.
However, I don’t need to settle on simply minimising the damage inflation inflicts my wealth. There are many high-dividend stocks out there whose yields beat the current rate of inflation.
I myself have bought FTSE 100 dividend stocks Rio Tinto and Persimmon for my portfolio. Their dividend yields above 11% and 15% respectively suggest I might actually make a positive real return on my cash.