The Powerful Concept of Hedging Your Own Consumption

Dear investor,

Welcome back to the free version of the Canadian Dividend Investing Newsletter.

We’re read by thousands of C-suite executives, millionaire investors, and regular folks just looking to get ahead. Great content in your inbox, each and every week.

This week’s edition is another good one. We’ll cover why buying what you know is a particularly powerful strategy in a way that you might not have considered before. In fact, it might even cause some of you to rethink parts of your retirement strategy.

Let’s get right to it.

Intro

Peter Lynch famously told retail investors they had an edge if they stuck with investments in companies and sectors they knew well.

One of the first areas where investors often apply this advice comes from a quick analysis of their monthly spending. They look at things like their electric, gas, or phone bill and start their investing journey there.

After all, it’s usually pretty easy to understand most utility businesses. They produce something we all need, and we buy it because there’s not really any other choice. Competition might exist, but it usually takes the form of nearly identical operators offering very similar services.

Take Canada’s telecoms as an example. There’s virtually zero difference between an iPhone that uses a network supplied by Telus (TSX:T) versus one that uses a network supplied by Bell (TSX:BCE). It’s the same experience. Therefore, it’s a utility.

Thus, many investors end up buying shares in their local utility. They buy what they know and relax, assured in the assumption that utilities are usually pretty solid investments.

But it turns out that there’s an even better reason for investing in utilities, a simple yet powerful rule that often gets overlooked.

Inflation protection in retirement

I’ve talked to hundreds of different investors over the years, and most have the exact same fear about their retirement years.

They’re worried that inflation will rear its ugly head and evaporate their once robust savings into something much less. Some event happens, their portfolio gets hit, and suddenly they’re stuck eating cat food for lunch every day.

There are countless examples of this happening in history. Just ask people in Venezuela, Argentina, or Zimbabwe.

Doomer porn advocates don’t help, either. It seems like every time the market falls 5% guys like Robert Kiyosaki come out of the woodwork and start spouting warnings about the MOTHER OF ALL CRASHES. RUN FOR YOUR LIVES, DOOMSDAY IS UPON US. HOPE YOU STOCKED UP ON CANNED GOODS, SUCKA.

This doesn’t just convince your moron brother-in-law, either. Reasonably smart people get swept up in this nonsense too. They can’t help it; fear is a powerful motivator.

Fortunately, there’s a really easy way to protect your retirement nest egg from future inflation, by using a ridiculously easy concept I call hedging your own consumption.

How it works

Hedging your own consumption is simple. You:

• Make a list of your biggest expenses in retirement

• Invest in reasonable proxies for these expenses

• Retire in confidence

Yes, it really is that simple.

If someone fears ultra-high electric rates, then the best way to guard against that is to own shares in the electric company. The provider of electricity is likely to profit in such a scenario.

That might not go far enough for some people, so you can kick that up a notch. You can invest in the fuel that powers the underlying power plant to further hedge your consumption.

For instance, I live in a city where the municipality owns the local utility. So I can’t invest in it directly. But I can invest in Capital Power (TSX:CPX), which owns the nearby plant that powers the city. I also know that plant uses natural gas, meaning I can further hedge my power consumption cost by doing something like buying shares in Tourmaline (TSX:TOU), a leading natural gas producer.

And then I can invest in Fortis (TSX:FTS) as a reasonable proxy for my local utility, completing the trifecta.

Why is it so powerful?

This is a valuable way to invest because it takes away many of the fears surrounding retirement.

If inflation does rear its ugly head and your monthly bills end up higher than expected, such an investment approach protects you. You can rest easy, knowing that the pain inflicted by the bill is being felt positively in your investment account.

Besides, such an approach has also delivered some solid investment returns.

For instance — say 20 years ago an Ontario retiree put $20,000 into Enbridge (TSX:ENB) stock to hedge their future bills. That investment would be worth more than $147,000 today, while generating almost $58,000 in total dividends.

That translates into a total return on your money of 10.49% per year.

If you run the numbers on similar investments, the results Also end up pretty good. Fortis delivered a 9.08% annual total return over the last 20 years. Telus gave investors an 8.68% annual total return during the same period.

Another main benefit

There’s another powerful reason why such an investing mentality makes so much sense.

It creates a long-term investing horizon. 

Think about it; your utility bills aren’t going away. They’ll exist in one form or another for as long as you’re on this planet. They might be included in an overall housing cost when you’ve moved into seniors housing, but they still exist.

Therefore it becomes really easy to commit to owning these stocks for multiple decades, and that’s when the real compounding starts to happen.

The psychological benefit

I inevitably get crap when I share this concept, mostly from people who don’t think that simple ideas can generate solid returns.

What these naysayers are missing are the powerful psychological benefits.

I can attest to this personally. Paying my power bill became far less painful once I had enough Fortis dividends to cover it. My January gas bill doesn’t sting nearly as badly once I knew I had enough Enbridge dividends to pay for it.

This benefit is very real, and it encourages a long-term investing mindset.

It also makes opening up your bills a whole lot less stressful, and I’m a fan of removing stress from your life as much as possible.

In fact, I’m convinced a big reason why Warren Buffett is still alive at 94 is he largely avoided stress for his entire life. That might be easier said than done for a lot of you, but one way to financially do so is to hedge your consumption.

The bottom line

You don’t have to limit this to your utilities, either. My A&W dividends pay for my onion ring indulgences. My wife’s weekly coffee is covered by Starbucks dividends. Our bank fees are easily covered by bank dividends. And our gas consumption is covered by oil stock dividends.

It’s a really powerful concept that encourages long-term investing in companies that have very real moats, dependable revenue, and that offer their shareholders inflation protection via consistent dividend increases.

Despite these advantages, it gets no attention in a world where stocks move by 20% on better than expected earnings. And why would it? It’s downright boring in comparison.

Boring investing gets a bad rap, but it works. Putting your capital into old-school companies with solid moats and predictable cash flows really can translate into a prosperous retirement, especially with the psychological benefit of knowing that these investments will pay for some of your most important expenses.

Canadian Dividend Investing has one mission — to help our readers select excellent dividend stocks. 

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