Like the world and the cost of living, nothing stands still. Investment portfolios can’t stand still either. They must generate an income stream that, over time, grows at a rate that at least equals inflation.
If you are in the workforce, inflation-protection comes from those hard-earned wage raises. But once you have retired from the workforce you’re on your own; there is no boss to turn too.
Retirement means that you are now fully reliant upon your investment portfolio, not only for your current income, but also for your future income. In order to maintain your spending power over time, your portfolio must generate growth in your income stream, at a rate that at least matches inflation. Hence, the importance we place on the concept of ‘yield inflation’, or ‘income growth’.
While fixed income is terrific for lots of things, ‘income growth’ isn’t one of them. Fixed income is unbeatable if you are looking for security of income and capital. It also does an excellent job of providing an investment portfolio with a buffer against instability. But, fixed income is not the place to be if you are looking for ‘yield inflation’.
Analysing the income stream from fixed income depends on changes in interest rates, and as we know these move up and down in cycles. They do not continually increase over time.
Incorporating a few growth assets like real estate and shares can provide some protection from inflation. Shares provide returns in two ways, capital growth and dividends. Capital growth comes from a rising share price, while dividends are an income stream that is paid by the company to shareholders out of profits.
Reputable companies endeavour to not only pay a solid dividend but also increase this dividend over time. It is these dividend increases that provide investors with inflation protection.
Numerous NZ companies have long track records of providing growing dividends for shareholders.
Of cause it is not just NZ companies that grow dividends. In fact, Australian and international companies tend to have more scope to grow profits and dividends because they have more growth opportunities. Because of this they tend to pay out a lower portion of their profits as dividends, leaving them more cash to reinvest in their companies.
While it may seem like investing in shares for ‘income growth’ sounds simple – buy a range of shares that have grown their dividend and have the potential to continue this in future and we don’t ever again have to worry about inflation.
Sadly, reality gets in the way of a great theory such as this. Sometimes companies that have had a track record of growing their dividend hit problems, with their dividend and share prices falling as a result.
When adding shares to your investment portfolio for income growth, looking for shares that have a solid track record of dividend growth is an important place to start, but diversification and judgment remain equally as important.