Keeping Up with Inflation

People don’t talk much about inflation these days. Since 1914, the average inflation rate in the United States is 3.4%. In 2009 and 2010, inflation was well below the historical average. The year 2011 saw a return to more normal levels.

Inflation of 3.4% seems pretty tame, especially for any of us who remember the 1970s and 1980s when inflation hit double digits. But even at 3.4%, your buying power is cut in half after 20 years.

Because inflation is low today, people underestimate its erosive powers. Despite the fact that for the past decade inflation has averaged nearly three quarters of a point below the historical 3.4% figure, buying power has still been cut.

What would have cost $1,000 in 2001 cost $1,270 at the end of 2011.

And what if you’re saving for something whose price rises faster than the average 3.4% rate, such as college tuition or retirement (and the associated medical costs)?

For example, in 2011, the College Board reported that tuition at public four-year universities increased 8.3%. And since 2006, it has risen at a rate 5.1% above the inflation rate.

Where are you going to find an investment that will grow 8.3%? Today, if you lock up your money for 20 years in a treasury, you’ll be lucky to get 3% per year.

Let’s see how cost increases could impact tuition fees in the future. Right now, tuition for in-state students at a public university averages $8,244. Private university students are paying an average of $28,500. If those tuitions continue to increase by 8.3% per year, in 18 years, you’ll have to shell out $34,629 per year for the public university and $119,717 for the private school. And that doesn’t include room and board (or beer). Sure hope your kid can hit a jump shot.

So if you’re lucky enough to be able to buy $100,000 worth of treasuries for your newborn child’s education, and they pay 3% per year, you should be where you need to be to pay tuition for four years, but you’ll still have to come up with some cash for room and board, books, and more (beer). But remember, this is just an in-state school. At the private university, forget it. You need to average a 9% compound return per year to hit your target.

This is an extreme example, but you can see that treasuries are a tough way to fund any future expense. One of the problems with fixed income is that you can’t reinvest it in order to let it compound, the way you can with dividend stocks.

As you’ll soon see, a 12% compounded annual return is readily achievable when you invest in stocks that pay dividends. In fact, if you reinvest those dividends, there is no reason why you shouldn’t be earning 12% per year, over the long run.

12%. That was not a typo. You can earn that much per year (and even more) by investing in boring, large-cap, dividend-paying companies that simply match the overall return of the market. And at 12% per year, all you need to do is start off that college fund with $1,000 and add $2,000 per year and the in-state school is entirely paid for by the time your little boy or girl graduates high school.

We’re not taking any extra risk here. We’re not investing in speculative companies with new technologies that may or may not work. All we are doing is trying to match the market with companies that have a long track record of paying shareholders. But through the system I’m about to show you, it can help you achieve your financial goals.

You need to know which types of dividend stocks to buy in order to achieve the maximum returns. So now, let me show you.