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.

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