Vanguard Dividend: Inflation Protection

08/04/2014 9:00 am EST

Focus: ETFs

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

The easiest way to protect against rising inflation is to hold companies that have strong pricing power and are easily able to pass along higher costs, explains Benjamin Shepherd, editor of Inflation Survival Letter.

One way to separate the wheat from the chaff in terms of firms with pricing power is to look at their dividend yields. Companies that have consistently increased their dividend payouts across business cycles—particularly inflationary bursts—clearly must have that clout.

If I had to pick the single best investment to hold for the long haul it would be Vanguard Dividend Appreciation Index ETF (VIG).

While S&P 500 (SPX) companies were slashing dividends during the crash, this fund’s constituent companies, by and large, held steady with their payouts.

Vanguard doesn’t disclose the precise method it uses to construct the fund’s index, but its process is clearly focused on high quality securities. For example, a company only merits inclusion if it has increased its dividend in each of the last ten years, a period that includes—not only the recession—but the inflationary run up to it.

The average stock in the fund’s portfolio tends to command a lower price-to-earnings multiple than the S&P 500, while having higher historical sales and earnings growth. The fund’s constituents also have lower payout ratios and clean balance sheets.

 As a result, the ETF strikes an excellent balance between growth and value investing, while ensuring that its holdings pay growing and sustainable dividends.

Many of the fund’s holdings—including names such as Johnson & Johnson (JNJ), Coca-Cola (KO), and Exxon Mobil (XOM)—are recognized as clear leaders in their industries. The fund also allocates just 6.3% of assets to the financial sector versus the S&P 500’s 14.3% allocation.

Over short-term periods, the ETF often lags the broad market. But its defensive nature and clear-cut pricing power is what ultimately makes the fund an ideal candidate for a long-term, core portfolio holding.

And, in keeping with Vanguard’s tradition as a low-cost leader, its annual expense ratio is just 0.10%, making it one of the cheapest large-cap ETFs available.

As a result, it is an inexpensive option for adding an inflation-beating stream of income to your portfolio while providing downside protection in the event of a correction.

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