Should I Invest In Dividend Or Growth Stocks?
To someone learning how to invest in the stock market, the amount of options you have can be somewhat overwhelming. Stocks, bonds, annuities, options, forex, ETFs. It can all be a little too much to think about.
I’m going to take a little time to go over the most popular investment vehicle that most investors choose, stocks. In my opinion, there are three directions you can head in when it comes to stocks. You are either investing for growth, income, or a combination of the two. Let’s clearly define them before I move on.
Growth Stocks: Growth stocks are shares in a company that is expected to grow at a faster pace than the market. Growth stocks typically do not want to pay a dividend to its share holders. This is because they would much rather invest that money into future projects, products or services to grow the company. This, in turn, increases its share value.
Income Stocks: An income stock is a stock that pays dividends. For the most part, income stocks are companies that have already established themselves as a profitable business. Instead of investing all their excess capital into future products or projects, they may take a certain amount, usually issued per share, and grant it to shareholders in the form of cash.
So why should I invest in growth stocks?
Before I explain why you should be investing in growth stocks, let’s make something clear. Growth investing is NOT value investing. Value investors may be looking to find that diamond in the rough(a company that is priced below its intrinsic value). Whereas growth investors are far less concerned about a stocks current price as they are its potential future.
A prime example of people taking advantage of growth investing was the dot-com boom. I won’t go over the logistics of why most were digging their investment portfolios an early grave. But it’s an example nonetheless.
Growth stocks have the potential to provide better than average market returns to an investor if they are good at picking them. Growth stocks tend to be a riskier investment. This is due to the fact that you are investing in a company that needs to do the right things in order to realize that growth.
All this being said, my mentality has always been that younger investors are more suited for growth stocks rather than income stocks. There are three main reasons for my theory:
- Younger investors have time to recuperate their portfolio if they make riskier growth investments and lose. Whereas older investors near retirement may not have the comfort of regaining their capital if lost.
- Dividend stocks need capital to generate substantial income, and lots of it. A $100 000 portfolio yielding 4% is only generating $4000 in income a year. Considering most dividend investors would like to live off that income when they retire, you can see how big of an investment portfolio you’d need.
- A growth stock portfolio has a bigger upside than a dividend portfolio. This higher rate of return, albeit risky, can pay off huge and set one up with a much larger portfolio when they transition to a safer dividend portfolio.
Why should I invest in dividend stocks?
The idea of getting cold hard cash from a huge corporation leaves people feeling all warm and fuzzy inside. Apple paying ME money? Great!
Dividend investing is often associated with less risk. Although not always true, it depends on how you structure your portfolio. Often, dividend stocks are heavily weighted into certain sectors that are practically bulletproof: Telecommunications, utilities, and the financial sector. There is an exception to every rule of course. But for the most part, these companies aren’t going anywhere anytime soon.
By bulletproof, I typically mean that these companies, although not invincible by any means, can resist most economic disasters or slumps. To a 50 something investor who plans to retire in the next 5 to 10 years, you can see why they would be more inclined to invest in these stocks, rather than growth stocks. Growth stocks in some cases can experience extreme amounts of volatility during market downturns.
That being said, here are my three main reasons investors should be looking at dividend stocks. Make sure to note that my theories are based on proven companies that have issued and increased dividends over the long-haul.
- Investing in companies who have a long history of increasing and paying dividends can benefit an investor immensely during an economic downturn. Even if the price of the stock itself falls, the dividend will stay the same, and can often lead to more buyers of the stock as the price falls due to the yield becoming irresistible.
- Dividends are typically paid by companies who have well-established roots in their industry and are in sectors that are resistant to economic downturns. A prime example of this is an industry leader in the utility sector. Everyone needs gas and electricity, regardless of the state of the economy.
- Investors have the ability to DRIP (Dividend Reinvestment Plan) their dividend payments back into the companies that pay them. This allows investors to reinvest their money back into the companies and create a snowball effect.
If you’re interested in checking out some dividend stocks to add to your portfolio, check out this list of the top 10 Canadian dividend stocks and the top 5 dividend stocks for 2017 by Jen Wieczner from Fortune.
So what exactly is the best investment strategy?
The state of the economy plays a large part in what exactly you should be doing with your portfolio. There is no investment strategy that doesn’t require consistent tweaking and attention. For example, an investor investing solely in dividend stocks during the dot-com boom would be making a grave mistake by not taking advantage of the huge value in growth stocks at the time. On the other end of the spectrum, a growth investor during the market crash of 2008 would have faced heavy losses.
A solution to getting the best of both worlds is combining the two. As of right now, because of the economic uncertainty, the majority of the stocks in my portfolio are strictly dividend paying stocks. But that is not to say I do not have any growth stocks in my portfolio. If we reached another situation where growth stocks were predicted to out perform dividend paying stocks, I would simply adjust.
There is no one stop solution to investing. In order to reach your goals, you need to find the right mix of risk and security. There may be an answer to what you should invest in at the current time, but it is ever changing. The best investors will be the ones who can spot and react to certain market conditions.