The best inflation hedges turn out to be the simplest
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If you want to protect yourself against the risk of resurgent inflation and you have some savings to spare, you could do worse than just invest them in the stock market, where dividend income has grown impressively in real terms.
Why it matters: People whose earnings come from labor have seen much less income growth than those who rely on the stock market.
Driving the news: Inflation refuses to die, and it's still by far the topmost concern of voters. Which raises the question: If prices are going to keep on rising, what kind of income will keep pace?
The big picture: A lot of financial literature looks at what asset prices do during times of inflation, rather than thinking about what kinds of income tend to keep up with inflation.
- Commodities, for instance, are often considered to be a natural inflation hedge, but they don't generate income.
- Owning oil or steel or gold will only help you buy a dozen eggs if you first sell some fraction of what you own. In that respect, commodities are very different from a stock portfolio that provides dividend income regardless of whether the market is going up or down.
Follow the money: The last big bout of inflation took place between January 2021 and July 2022, during which period consumer prices rose 12.3%.
- During that time, median earnings rose just 8.9% — a 3.4% pay cut — in real terms.
- S&P 500 dividends, by contrast, rose 13.3% in those 18 months, outpacing some of the highest inflation the U.S. had seen in living memory.
Between the lines: The consistent outperformance of stock market dividend income comes despite the long-term trend of companies shunning generous dividends, preferring to use their profits to buy back their shares instead.
- The dividend yield on the S&P 500 ended 2024 at just 1.27%, lower than almost any other point over the past two decades.
- Corporate profitability, however, is at record highs, meaning stockholders who share in those profits are seeing record levels of income.
Of note: The purest and simplest inflation hedge is TIPS: Treasury bonds that are indexed to inflation. Yields on TIPS are broadly positive, meaning you're guaranteed to outperform inflation by about 2% if you buy a 10-year bond.
