Should I Continue to Invest in Dividend Stocks During a Rising Interest Rate and Inflationary Environment?
Many investors turn to dividend stocks for income which can be especially attractive in a low interest rate environment. But what about a rising interest rate environment when there are potentially other types of investments whose yields may start to look attractive? Do dividend stocks perform well in periods of high inflation?
In this article we provide some thoughts about investing in dividend stocks in a rising interest rate and inflationary environment.
How Can Rising Rates & Higher Inflation Impact Your Dividend Investing Decision?
1. Rising Rates Do Have Some Impact on Corporate Profitability
Many publicly traded companies have some debt on their balance sheet to fund operations. Borrowing costs increase when interest rates rise, which, depending on the company’s leverage, can have a negative impact on its balance sheet. This also has the potential to reduce a company’s cash flow resulting in a higher percentage of its cash flow being used to pay dividends.
2. Other Sources of Yield May Begin to Look Attractive
Stocks typically perform better than bonds in an inflationary period as inflation is typically detrimental to fixed rate debt. While interest rates on Treasury Bonds have increased as interest rates rise, they remain at relatively low levels.
What is Missing from The Picture?
1. Some Dividend Stocks can Thrive when Interest Rates & Inflation Increase
Not all dividend stocks are the same. While some industries can perform poorly when interest rates rise (for instance, those heavily reliant on borrowed money), others can benefit from rising interest rates and inflation. One example would be banks, for whom rising interest rates are generally positive. A bank’s core profits come from lending money. When interest rates rise, banks can charge higher interest on loans. Another example would be a company that is able to pass on any increased costs due to inflation directly to its customers possibly resulting in higher earnings.
2. Some Dividends Can and Do Increase with Inflation
Interest rates hikes often go hand in hand with rising inflation. Inflation is a bond investor’s worry and worst enemy. Inflation can erode the purchasing power of future cash flows—especially when there is no chance of increasing this future cash flow (e.g. fixed coupon payments on bonds). However, some dividend payers are able to charge higher prices for goods and services resulting in an increase in cash flow which they can use to pay out to shareholders in the form of increased dividends.
3. The Total Return Approach
Dividend investing is a total return approach. While rising interest rates and inflation can negatively impact stock prices, remember that your overall returns are made up of 1) dividend payments and 2) potential capital gains. Volatility in stock markets makes it difficult for investors to preserve their capital while attaining a reasonable level of income. Dividends can effectively provide a backstop for these stocks and can therefore help you maintain a healthy overall return during times of market volatility as you are getting “paid to wait.”
Dividend Growers are Your Best Friends
Rising rates, inflation, and market volatility combine to make an economic situation in which it can be challenging to build wealth, let alone preserve it.
So, should you continue to invest in dividend stocks in a rising interest rate and inflationary environment? The answer depends on which dividend stocks you are investing in.
- You may wish to align your portfolio with industries that can benefit from rising interest rate rises and/or inflation.
- Dividend growers can be your (all-weather) best friends.
Diversify and Think Long Term to Protect, Preserve and Build Lasting Wealth
Instead of trying to “time” the market, you may wish to diversify and think “long-term” by having an investment portfolio that is designed to protect, preserve and build lasting wealth.
Established in 1985, Bloom Investment Counsel, Inc. is a Toronto-based independent, privately-owned boutique investment management firm with over 37 years of experience managing in excess of $2.5B in assets over the years. We have successfully managed our clients’ money through previous rising interest rate and inflationary environments, focusing on dividend-paying stocks.
We specialize in providing customized, actively managed, Canadian and U.S. dividend-paying portfolios to generate a total return through capital appreciation and a steady stream of income for wealthy individuals, family offices, foundations, corporations, institutions and trusts. Our long-standing clients speak to our commitment and ability to protect, preserve and build wealth over the long term.
Learn more about our personalized portfolio to create stable cash flow or get in touch with a senior member of our team today.
This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.