Retirement is supposed to be a relaxing reward for decades of hard work and responsible saving. Unfortunately the reality is that too many either cannot afford to retire or cannot relax as they see the rising cost of healthcare eat away at their nest egg.

#-ad_banner-#The growing cost of aging does not appear to be getting any easier. Healthcare inflation is among the highest across all groups of goods and services at an average rate of 3.4% over the last 10 years, against an average 2.3% rate of inflation in consumer prices.

The graph below shows inflation in healthcare costs and the difference between healthcare inflation and the increase across all consumer prices. In only two of the last twenty years have healthcare costs not increased faster than general inflation. And when that happened, costs jumped the following years.

Not only do healthcare costs grow faster than other costs, but people over 65 years old pay a disproportionate amount of their income to healthcare — an average of $5,069 a year in healthcare costs, 12.2% of their total spending and well above the 7.1% spent by all others.

Fortunately for investors looking forward to a long-deserved retirement, the problem may be part of the solution.

Hedging With Healthcare And High Dividends
They say that if you can’t beat ’em, join ’em. That may never be truer than in positioning your portfolio for the rising cost of healthcare. If rising healthcare costs mean higher sales for healthcare companies, then investors may be able to hedge some of their own higher expenses by owning some of those same companies.

As of October 24, 76% of healthcare companies that have reported third quarter earnings have beaten expectations for sales and 86% have beaten earnings expectations. Sales growth of 10.2% is the highest across any sector and earnings are jumping at an average 12.4% against the same quarter last year.

Not only are healthcare companies poised to book higher sales over the years to come, as a mature industry they are also likely to increase their dividend payout at a strong rate. In fact, the three companies below all have compound five-year dividend growth that is more than twice the ten-year average rate of healthcare inflation.

Living and medical costs have grown faster than any other group with a 5.8% annual increase in hospital services over the last decade. Ventas, Inc. (NYSE: VTR) is a REIT in the healthcare industry with properties across hospitals, clinics and long-term care.

CEO Debra Cafaro estimates that less than 15% of U.S. healthcare properties are held by tax-efficient REITs, leaving lots of room for future acquisitions and growth. The shares pay a 4.3% yield and the dividend has grown by a compound rate of 7.2% annually over the last five years.

Medicinal drug prices increased just 0.45% in 2013 as a result of changes to government reimbursement programs, but increased an average of 3.1% in the prior two years. Johnson & Johnson (NYSE: JNJ) books 39% of total sales from its pharmaceutical division. Added diversification across medical devices and consumer products helps to keep volatility in the share price extremely low, just 61% of the general market. 

Shares pay a 2.7% yield with a compound growth rate of 7.4% annually over the last five years. Not only does the company pay out a healthy dividend, Johnson & Johnson has returned $5.5 billion to investors through share repurchases over the last year and has generated $15.8 billion in free cash flow.

While the 10-year average for inflation of health insurance is just 2.3%, costs are extremely volatile jumping 10% in 2007 and 12% in 2012. Aetna, Inc. (NYSE: AET) operates across three segments in health benefits: healthcare, group insurance and large-case pensions.

While margins may come under pressure from lower insurance premiums, the company should benefit from the increase in insured Americans due to the Affordable Care Act. Shares pay only a 1.1% yield, but the dividend has grown at a compound rate of 41% since 2009. Aetna is also a strong buyer of its own shares with $1.5 billion in repurchases over the last year, nearly five times the amount returned through dividends.

Risks To Consider: Past performance is no indication of future returns, and there is the risk that these three stocks will not outperform inflation in healthcare costs going forward. Diversify your portfolio across other names within healthcare and in other sectors to fully minimize risk.

Action To Take –> As you approach retirement you should start thinking about hedging your largest costs with stocks that will benefit from rising spending in the sector. Pick best-in-class companies that have strong cash flows and have grown their investor cash returns at an inflation-beating rate in the past.

If you want to learn more about the power of dividend payers, then StreetAuthority has something for you. My colleague Amy Calistri puts high-yielding investments to work for you and your retirement in her premium newsletter, The Daily Paycheck. Her strategy is so successful that she was invited to speak in front of a live studio audience at St. Edwards University. To find out how she got a dividend paycheck for each day of the year, click here.