A:

Stock dividends protect against inflation by providing tangible returns that supplement capital returns from rising stock prices. Investors can use the cash from dividend payments to boost their purchasing power and offset the effects of inflation. During periods in which inflation outpaces stock gains, dividends help close the gap, and in some cases, eliminate it completely by putting additional cash into the hands of shareholders.

A stock dividend is a periodic cash payment made to shareholders, usually quarterly. Dividends are considered tangible returns because an investor realizes them while holding the stock. Capital returns, which represent the gain from selling a stock at a higher price than it was purchased, are not realized until the stock is sold.

The dollar amount of a stock dividend as a percentage of the stock's share price is known as the dividend yield. For example, a stock trading at $100 per share that pays a $3 annual dividend per share has a 3% dividend yield.

Some people reinvest their dividend payments, while others use them to supplement their discretionary income and boost their purchasing power. Because it manifests as rising prices on consumer goods, inflation makes it to where people need more money to maintain the same standard of living. Dividends provide a source of extra money even when wages and other investment income is stagnant.

Dividends also help close the gap during periods in which inflation erodes wealth by outpacing portfolio gains. Suppose an investor has his money in a stock that gains 7% in a given year. However, the inflation rate spikes during the same year and reaches 10%. Even though the investor gained 7% on his stock, he is worse off than where he started in terms of purchasing power. However, if during that same year his stock also has a dividend yield of 3%, the investor's dividend closes the gap between inflation and stock growth and allows him to break even.

Dividend yields are not usually enough to offset the effects of inflation completely. However, they serve as an excellent partial hedge against rising prices. Between 1992 and 2012, inflation averaged just under 2.5% per year. During the same period, dividend yields on the S&P 500 averaged just under 2%. Therefore, in a typical year, dividends from S&P 500 stocks offset 80% of the inflation from that year. During one year, 2009, dividend yields were greater than 3% while inflation was negative. Granted, 2009 was an atypical year marked by a deep economic trough and nascent recovery.

Under normal economic circumstances, market gains outpace inflation. However, the effects of inflation still mitigate an investor's portfolio growth. Dividends help reduce the negative impact inflation has on investments by providing extra income and offsetting purchasing power losses.

RELATED FAQS
  1. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  2. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
  3. What types of companies offer the most dividends?

    Find out which types of companies tend to offer the most dividends, and learn why dividends must be considered carefully ... Read Answer >>
  4. What metrics should I evaluate when looking for high-yielding dividend stocks?

    Evaluate high-yield dividend stocks to determine if they are a good investment to produce steady income. Learn what questions ... Read Answer >>
  5. Are dividends the best way to make money for retirement?

    Using dividends for retirement income can provide a hedge against a variety of risks, but investors need to be aware of the ... Read Answer >>
Related Articles
  1. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  2. Investing

    Why Dividends Matter

    Seven words that are music to investors' ears? "The dividend check is in the mail."
  3. Investing

    5 Reasons Why Dividends Matter to Investors

    Learn five of the primary reasons why dividends are of significant importance for the overall performance of stock market investments.
  4. Investing

    Dividend Yield For The Downturn

    High-dividend stocks make excellent bear market investments, but the payouts aren't a sure thing.
  5. Investing

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
  6. Investing

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  7. Investing

    Put Dividends to Work in Your Portfolio

    Find out how a company can put its profits directly into your hands.
RELATED TERMS
  1. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Indicated Yield

    The dividend yield that a share of stock would return based on ...
  4. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  5. Dividend Policy

    The policy a company uses to decide how much it will pay out ...
  6. Dividend Rate

    The total expected dividend payments from an investment, fund ...
Hot Definitions
  1. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
  2. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  3. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  4. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  5. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  6. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
Trading Center