UK inflation rose to 3.1% in November, the highest level in almost six years. Rising prices of food, transport and other products such as computer games contributed to the rise, squeezing the cost of living for many UK families.
A 3.1% inflation figure is bad news for both consumers and investors. Not only does it translate to a higher cost of living today, at a time when wages are growing at a snail’s pace, but it also erodes the future purchasing power of your savings and investments. This potentially means less spending power in retirement.
Silent killer of your retirement plans
Consider this example. Let’s say you have £10,000 saved right now. It’s sitting in a regular bank account earning no interest. If inflation runs at 3% for the next three years, your purchasing power, in today’s terms, at the end of the three-year period will be just over £9,100. In other words, you’ll be able to buy considerably less. It’s not rocket science to realise that you have to protect yourself from this silent enemy.
Saving is not enough
While saving cash in a ‘high interest’ bank account earning 1.5% or so is clearly better than not saving at all, it’s still not enough to grow your wealth over time. Inflation will still erode your spending power. Money saved in that kind of account is still going backwards, albeit at a lesser rate.
To combat inflation, you need to invest in assets that will pay you a return that is higher than inflation now and that will grow at a rate higher than inflation in the future.
Dividend growth protection
This is where dividend growth stocks have an advantage. These are dividend-paying companies that regularly increase their payouts. It’s important to distinguish dividend growth stocks from high-yielding dividend stocks such as Shell, GlaxoSmithKline and HSBC.
While these three companies all have high dividend yields of over 5%, a plus because that’s higher than inflation, there’s a flaw that many investors neglect. All three companies have frozen their dividends in recent years.
So the investor who receives an income stream from these three stocks alone, will lose considerable purchasing power over time, if inflation continues to run at a high rate and the dividend payments remain flat.
The way around this is to focus on companies that consistently lift their payouts by at least 5% per year. That way, not only can you build an income stream that is greater than inflation now, but the income stream should continue to grow faster than inflation in future. The result is that your purchasing power will increase over time, instead of decreasing. That translates to more financial freedom in retirement.
FTSE 100 dividend growers
Glancing at the FTSE 100 now, there are plenty of dividend growth stocks that could help you beat inflation. For example, Imperial Brands currently yields 5.6%, and has increased its dividend by 10% per year for nine consecutive years now. Analysts expect the dividend to keep growing at a similar pace in the medium term. Similarly, Lloyds Banking Group is forecast to pay 4.1p in dividends this year, a yield of 6.2% at the current share price. Analysts expect the bank to lift its payout by 12% next year.
Don’t let inflation erode your future spending power. Focus on dividend growth to protect yourself.
Edward Sheldon owns shares in Imperial Brands, Lloyds Banking Group, Royal Dutch Shell B and GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings, Imperial Brands, Lloyds Banking Group, and Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.