If you’re an investor looking for income, the Fed has declared war on you. Are you ready to fight back?
The Fed has two main weapons in this war: ZIRP (zero interest rate policy) and QE (quantitative easing). Through ZIRP, the Fed makes sure you earn almost nothing from traditionally safe sources of income, such as money market accounts and Treasuries.
This zero-rate environment forces you to buy other income-producing assets, such as stocks that pay dividends. ZIRP has worked – investors have flocked into dividend stocks of all stripes this year. That’s where the Fed’s other weapon comes in.
With its money-printing QE program, the Fed is secretly stealing a portion of your dividends every year. Let me explain…
The “Real World” Inflation Rate
If you’re buying income-producing assets, it’s likely you’re planning to use some of that income to cover your living expenses. Naturally, if your living expenses are increasing, your income needs to grow at the same pace. Otherwise, you will lose purchasing power, and your standard of living will decline.
While the Fed wants you to believe inflation is low, the rising costs of everyday items such as gasoline and food suggests otherwise. In the past year, I’ve noticed a significant increase in my grocery bill – everything from meat to vegetables has grown more expensive. That makes me skeptical of the Fed’s low inflation numbers.
That’s why I’m a big fan of John Williams of Shadowstats.com. He keeps track of key economic data using “real world” methodologies. He publishes honest numbers, as opposed to the “fantasy world” numbers the Fed publishes.
The official inflation rate, for example, is 2%. But, using methodologies that were in place prior to 1980 – before the Fed started tinkering with the numbers – Mr. Williams shows the actual inflation rate today is about 9%. And with QE III, inflation is likely to remain high.
This means Fed-driven inflation will continue to steal a portion of your dividends. So, if you’re counting on investment income to cover your living expenses, you better make sure it’s growing faster than inflation.
Two Ways to Fight Back Against the Fed
The best way to understand how the Fed is stealing your dividends every year is through an example. Let’s take a look at AT&T, a popular dividend-paying stock.
In the past three years, the company has increased its dividend at an average annual rate of 2.4%. That growth is enough to beat the Fed’s fantasy inflation rate, but not the real world rate. That level of growth will not protect your standard of living.
If you are an AT&T shareholder, for example, you will receive $1.76 per share in dividends this year. This will buy you $1.76 worth of stuff. Assuming the same pace of dividend growth, next year AT&T will pay you $1.80 per share.
But, you won’t be able to buy more stuff – with inflation at 9%, that dividend will only buy you $1.638 worth of stuff. AT&T may increase the dividend, but inflation means you will actually lose purchasing power.
Blue chip firms such as IBM, Wal-Mart and United Technologies Corp. are a better income choice. Over the past five years, their dividends have grown at an annual rate of more than 10%. They provide protection against the Fed’s policies because they’re raising their dividends at a rate that outpaces inflation.
Since very few U.S. companies will be able to keep pace with inflation, you also have to look beyond our borders. The second way to fight the Fed is to invest in foreign stocks that pay dividends denominated in currencies that are bound to appreciate against a weakening dollar.
Healthy Income from Abroad
By collecting foreign dividends in stronger currencies and then translating them into dollars, you end up getting a higher payout as the dollar loses its purchasing power. That’s why it makes sense to add some international dividend-paying stocks to your portfolio.
Let’s take a look at another example. Sasol Ltd. (NYSE:SSL) is a global integrated energy and chemicals company. As a South African company, it pays dividends in South African rand. This is a great way to prevent the Fed from stealing your dividends. Here’s how it works:
From June 2010 to June 2011, the company raised dividends from R10.50 to R13.00, an increase of 24%. But, during that same period, the dollar was losing value because the Fed was running QE II, the second round of money printing.
As a result, the South African rand appreciated against the dollar, and U.S. investors saw an even bigger payout. In U.S. dollars, Sasol’s dividends actually grew 40% during that period. That kind of growth gives you a lot of ammunition to fight back against the Fed.
In the past five years, Sasol has grown its dividends at a compound annual growth rate of 14% … and that doesn’t even account for currency fluctuations. That’s what makes this company such a good addition to any income-producing portfolio.
In the coming years, the Fed will continue its war on your investment income. Make sure you fight back by adding some healthy, foreign dividend-paying stocks, such as Sasol, to your portfolio.