Fighting Inflation With Dividends | Podcast
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Fighting Inflation With Dividends

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[Dividend] stocks may not be a shiny new object…but they consistently deliver year in and year out.

Charlie Toole

Vice President, Portfolio Manager

How do you turn your portfolio into a paycheck? That’s the question most retirees face, and dividends can be an important part of the answer. Charlie, Steve and Andrew talk about the challenges of generating a stable, income-producing portfolio in an inflationary environment and how you can manage those challenges, including:

  • Why dividend growth is such a powerful indicator of a company’s health
  • When, how and how much you can rely on stocks to produce income
  • What it means to have a “battleship balance sheet”
  • …and why it’s more important than ever in this economy

Dividend-producing stocks can be a useful part of your portfolio whether you’re in retirement, about to be, or still saving—if you use them right. Listen now to learn how!

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Episode Transcript

Charlie Toole:

Hello, I’m Charlie Toole, a portfolio manager at Adviser Investments, and welcome to another The Adviser You Can Talk To Podcast. Joining me today is Andrew Busa, manager of financial planning. Andrew, welcome to the podcast.

Andrew Busa:

Good to be here.

Charlie Toole:

Also joining is Steve Johnson, vice president and portfolio manager. Steve, thanks for joining us today.

Steve Johnson:

My pleasure. You know this is a topic that I love to talk about.

Andrew Busa:

This is near and dear to your heart.

Charlie Toole:

Yes, it’s a very exciting topic for all of us: Dividend growth stocks—great asset class to own. But we’re going to center this podcast around how they fit into your financial plan and how they factor into your financial plan at different stages of life.

We’ll kick right off from the beginning, Steve, just with a quick review on what dividend growth stocks are. So I’ll kick it to you for that.

Steve Johnson:

Great. Well thanks, Charlie. Yeah, so dividend growth stocks—I think sometimes there’s a misconception about dividends, stocks and dividend growth. We like to focus on those companies that consistently are growing their dividend year after year, which means that they have a tremendous amount of free cash flow. It’s that cash that’s left over after everything, and what management decides to do with it is increase their dividend. That’s a little bit different than some folks who are looking perhaps at just the highest yielders, those companies that have a high dividend yield but maybe aren’t in the best shape.

One of the other things that we’re looking at is not only the growth of the dividend but also the balance sheet. When we look at companies, we want to make sure that they really have to have the highest quality, and we refer to them as battleship balance sheets—those balance sheets that are able to survive through different economic cycles, including the one that we’re in now. We want to make sure that those companies are going to be able to survive anything that the economy throws at it.

Charlie Toole:

Yeah, great point. The one thing we like to say is that as an asset class historically, those companies that—because they have that higher cash flow, because they’re financially stronger on the balance sheet, and because they’re raising those dividends year in and year out—they typically have higher returns than the overall market and lower risk. Andrew, I think that factors in well to a financial plan for our retiree.

Andrew Busa:

Yeah, absolutely, because when we think about retirement… And that’s a phase, a big shift in someone’s life, going from earning a paycheck every other week if you have a salaried position to then drawing on your portfolio to live and to pay for your expenses and to pay for the lifestyle that you want to have in retirement. I’ve heard you both talk about this since I’ve been here, and I’m a believer in it too: A dividend growth portfolio fits in very, very nicely with someone’s retirement picture, just because it does have that ability to generate income and supplement your other income sources. So for most people, that’s going to be Social Security, pension income if you get that, maybe a bond portfolio if you’re taking part in that.

But all of these things, when we’re building a retirement plan for somebody, it is a little bit of a puzzle figuring out: Okay, how are you going to turn your portfolio effectively into a paycheck? It seems to me that the dividend growth strategy has always been a very intuitive way for a retiree to understand how that could be possible. I feel like that’s how I’ve heard you both talk about it too.

Steve Johnson:

Yep. If we think about the environment that we’re in now, we have higher volatility, we’re coming off last year, where everyone made money, they were investing in meme stocks and growth stocks and crypto… I think for folks who are looking at dividend income, they’re focused. It keeps you on the path, especially with your financial plan, because you’re not looking at that shiny object. You’re not trying to double your money. You’re looking at the consistency.

In an environment where we’ve seen inflation the highest that we’ve seen in almost 50 years, the ability for those companies to grow their dividends, to give you a raise each year… I know Charlie talks about this all the time and has done studies and has shown even in our portfolio what the dividend growth has been. But that is crucial, especially in this fight against inflation.

Charlie Toole:

Yeah, absolutely. I think, Andrew, you mentioned it: Social Security, pensions, income from bonds or cash—this is just another supplemental way for folks to get income, especially from the more aggressive part of their portfolio because these are stocks, so they’re going to have a little bit more volatility than some of the safer income instruments. But with that higher volatility and that higher risk, you also get principal growth over longer periods of time. So that’s something, I think another benefit for this income-producing asset class. But to get to that point, it is a little bit more risky. But again, that’s something that you factor into the plan as well.

Andrew Busa:

Right. As you mentioned off the top, Steve and Charlie, mentioning that it’s almost… With this dividend growth strategy, it seems to me like a shortcut way of really finding these very high-quality companies. I think, Steve, to your point, and it’s a good one, is that over the last year and a half, two years, it’s been all about that shiny object, chasing those meme stocks, fear of missing out, whatever you want to call it. Behind the scenes, if you’re looking at these higher-quality companies with dividend growth, that’s really where you want to be, I think, long term, as a long-term investor. But maybe it doesn’t get as many headlines as a stock going way, way up and way, way down in a single day.

Charlie Toole:

No, absolutely. I think the one thing that we focus on, and I think that’s really a key, is consistency. This is something that, as we said, year in and year out, they’re consistently raising their dividend. We’re focusing more on people that might be in the retirement stage of life, but I think this can also be used for somebody that’s in the accumulation phase of their plan because, as we said, these are stocks, and they historically outperform the market. They may not be that shiny object that you’re talking about or that we’ve seen over the last two to three years, but again, they’re consistently delivering year in and year out. That can be a good anchor or a good core piece of even a younger person’s portfolio.

Andrew Busa:

Yeah, I was going to go there next. We’ve talked strictly so far about how this fits into a retirement portfolio, but I think definitely for someone who’s accumulating in their 30s and 40s as they’re building their portfolio. The nice thing too about fitting this strategy into that phase in life is that you can use potentially that income for other things, to pay for some other short- or medium-term expenses if you’re thinking about almost like a bucketing strategy for your different accounts. It can give you maybe some more flexibility around your cash flow. That’s one way that I would think about it fitting in there.

Steve Johnson:

You hit the nail on the head there. It’s all about cash flow in retirement and as you’re planning that. Let’s face it, retirees and even those who have had a lot of cash on the sideline, it hasn’t been a good environment for them because interest rates have been dismal. You haven’t been getting anything on your cash. Dividend growth has provided that. Also, now that yields have come up, to your point, you can balance this. You can have a dividend portfolio with individual bonds and be able to generate income, finally, that is not akin to what we saw in the ’70s and ’80s, but it is a much more normalized environment right now.

I guess the thing that we would stress is it’s been a very quick transition. We’ve gone from zero interest rates last year to now we’re looking at 3.5%. That, coupled with dividend growth, means that you have a better chance, I think, in retirement than what you had a year ago.

Andrew Busa:

I’ve been curious too just to ask you both a question: Over the last year, year and a half, it feels to me like investing has… There’s been this democratization. It’s become popular with different age groups and things like that. Has it changed how you think about putting together the portfolio? Or is it distracting at all to have that all out there in the headlines?

Charlie Toole:

I think it doesn’t distract us. We’re focusing on what we’ve been focusing on for the last decade-plus in what we do. But I think that it can be a distraction for clients. Clients are always looking for that next best thing or that shiny object, and it can distract them from maybe what they’re trying to accomplish in their financial life.

I had a lot of clients asking about technology stocks or ways to get more aggressive a year ago, and now those clients are asking different questions about how to protect and how to be a little bit safer. That’s part of our job as managers and financial planners—to focus the clients on their long-term financial objectives. I think that people can get distracted, but that doesn’t really distract us from what we do.

Andrew Busa:

Right, and I think that the dividend growth strategy, you get the best of both worlds. You’re getting that potential for long-term growth because you are invested in stocks. You mentioned you will experience volatility in any sort of stock, but at the same time, you are investing in a higher-quality company, hopefully limiting some of that volatility. Like you said, lower risk than the overall market is the goal.

Steve Johnson:

Andrew, I think your point though is one I don’t think we’ve spent enough time on in our business. Not just us, but in our business. I think this movement that we saw over the last couple years with Robinhood and just the ability to trade has really been detrimental. We’ve gotten away from long-term planning. We’ve gotten away from focusing on average returns over an extended market cycle, and it’s been very easy for folks.

Right now what we’re experiencing is it’s not so easy. We’re seeing some pretty big declines, whether it be in the NASDAQ this year, those meme stocks that we’ve talked about. There has been a lot of wealth destruction over the last 12 months as people have chased those ideas.

Even now, we’re talking about the death of a 60/40 portfolio, yet that’s still going to be an integral part of someone’s allocation—dividend-paying stocks and bonds. Something a little bit more maybe, I don’t know, boring. But over time, the power of compounding, the power of sticking to the plan—I think owning dividend-paying stocks along with fixed income keeps you on your plan, and I think it makes your job as a financial planner easier, as opposed to having to explain away volatility and the randomness of what we’re seeing with some of these other stocks.

Andrew Busa:

Right. Yeah. The way I’ve talked about it, and you both correct me if I’m wrong, but it seems like these companies that are rising rapidly, declining very rapidly—it’s psychological more than anything else. It’s not based on actual financial results, as opposed to these higher-quality companies, where you’re actually looking at battleship balance sheets.

Charlie Toole:

Yeah, I think that’s true. The growth starts out in those stocks from the fundamentals, but then I think people extrapolate the most recent quarter, the most recent year. They extrapolate it too far into the future, and that’s where you see the prices run up above the fundamental value of what the company’s delivering.

We saw that in the pandemic, whether it was Peloton or Netflix or Teladoc or any other of these COVID-winning stocks. Eventually it got to the point where anybody that was going to get a Netflix subscription or buy a Peloton bike, they’ve already bought that product, and that growth is not going to be sustainable for five or 10 years into the future. So we’ve seen what’s happened on the other side.

Steve Johnson:

Andrew and Charlie, your comments are spot on about this movement that we’ve seen. It appears that everyone was following these story stocks, or narrative investing, as I call it. Everyone had a narrative, and as long as they believed that, that’s where they were investing. What you saw was this incredible movement and momentum in these names that Charlie mentioned that had great growth expectations, but you can’t grow like that forever. As we’ve seen, a lot of that demand was pulled forward. We’re not seeing that demand anymore, and so those stocks have suffered, as opposed to the more consistent approach to having great balance sheets and being fundamentally driven.

I think, if anything, one of the good things that may come out of all of this is a more fundamental-based, more boring market where some of that momentum is done.

I think we saw that coming out of the tech bubble of 2000 to 2002, where we had a period where value outperformed, where people bought staples, utilities, banks coming out of that 2002 period. Maybe we’re entering another period like that. We can only hope that the fundamentals will rule again.

Andrew Busa:

Yeah, boring is… It’s good for investors and clients, but it’s not as good for the news.

Charlie Toole:

Doesn’t generate clicks.

Andrew Busa:

No, it doesn’t. The news and the media, they make it very difficult, I think, now more than ever, to be long-term investors. It’s something that Jeff DeMaso and I talked about on our last webinar, but I think it’s the truth.

Charlie Toole:

Yep, a hundred percent. I think that whether it’s stories about people making millions on a meme stock or… I think the latest one was a college student who made a lot of money on Bed Bath & Beyond.

Andrew Busa:

I saw that.

Charlie Toole:

There are all these stories, all these one-off stories that everybody thinks they can replicate. I think everybody’s looking for that next “get rich” scheme.

But I wanted to circle it back to one other… Speaking of headlines, the biggest, I think, headline this year has been inflation. Andrew, I know that you and I have worked on a number of client plans where we’ve factored in a higher inflation rate going forward just to see or to have a comfort that they were okay in their plan. So inflation is another one of those areas that we factor into the financial plan.

Andrew Busa:

Yeah, absolutely. It’s interesting. A few years ago, building plans, presenting them to clients, inflation was not something that we ever really spent much time on because it hasn’t been a subject that’s been on anybody’s mind. But obviously over the last year, it’s been a very hot topic.

The way we have approached this is we do have our baseline assumption of inflation that we do review annually with Charlie, with your help and the research team’s help. But we have this baseline moving forward, this cost-of-living adjustment of 2.5% every year. But at the same time, we want to stress-test plans for the worst-case scenarios. So when we’re looking at results with folks, we will often build in additional scenarios showing higher-than-normal inflation for long periods of time to see how sensitive a financial plan is to more inflation and to understand if that’s something that needs to be a concern or if it’s something that can give someone peace of mind—that they don’t need to worry about inflation running hotter for longer.

For something like health care expenses though, we will apply a more nuanced idea there. We’ll inflate those faster, especially in retirement, when we’re putting together a financial plan, just to be, again, conservative. We are looking at higher-inflation scenarios for folks and for health care expenses over time if those do rise faster than other day-to-day expenses, which they have tended to do historically. We want to be prepared for that possibility inside of a financial plan.

Charlie Toole:

I know, Steve, we’ve always looked at the income growth rate and what that is relative to inflation. And whether it’s the stocks that we’re managing in portfolios for clients or even just the broad dividend growth index, the income there consistently outpaces inflation. Typically, what we’ve seen… I believe this is going back over the last year: Inflation is up about 9% in just the broad dividend growth index. The income there is up almost 20%. So you’re seeing dividend—

Andrew Busa:

That’s huge.

Charlie Toole:

Yeah, yeah, yeah, this is income that’s rising, and it’s rising faster than inflation. So again, this is one of the reasons why we like the asset class, and it’s a great thing for people in retirement to be able to count on that income continuing to grow.

Andrew Busa:

Yep, absolutely.

Charlie Toole:

All right, well I think that’s a great place to wrap up. Thanks, Andrew and Steve.

As we discussed today, dividend-paying stocks are a great way to generate income, protect against inflation and grow principal for investors in retirement.

This has been Charlie Toole, Andrew Busa and Steve Johnson from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts, and your feedback is always welcome. So if you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com.

Before closing, I’d like to thank Kailey Steele and Ashlyn Melvin. They do all the hard work making this podcast possible. And thank you for listening today.

 

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