Growth stocks and dividend stocks fulfil different investment goals, but both potentially belong in your portfolio. Here’s what you need to know about these two popular investments.
Growth stocks and dividend stocks may seem to represent opposing investment theses. One eschews short-term gains in exchange for the chance at a large payout in future, while the other revolves around achieving a sustained drip-feed of income from the get go.
Neither is superior to the other — they are simply two different ways of investing. And while they may have many differences between them, growth stocks and dividend stocks share a common core, that of capitalising on the stock market in order to accumulate wealth.
In this article we break down the differences between dividend stocks and growth stocks, how they work, and the role they play in an investment portfolio.
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Side-by-side comparison: Growth stocks and dividend stocks
|Growth stocks||Dividend stocks|
|Focuses on younger companies with disruptive or revolutionary potential||Focuses on companies in stable, profit-earning phase|
|Requires longer investment timeline to see results||May start producing results quicker|
|Higher potential for capital gains||Capital gains may be slow or even non-existent|
|More volatility||Less volatility|
|Lower liquidity during investing||Higher liquidity during investing|
Understanding growth stocks
What are growth stocks?
Growth stocks often refer to companies that have a high potential to grow quickly and raise their valuation, which translates to higher share prices.
Some of the most prominent growth stock companies in the past decade or two are also today’s biggest household names — think Google, Facebook, Apple, Amazon and Tesla.
You may have noticed some common threads among the companies mentioned above — they are all relatively young and yet have successfully disrupted their respective sectors. As they grew into the multi-billion behemoths they are today, their share prices inflated, rewarding investors who got in early with massive capital gains.
In case you think you’re late to the party, don’t worry. Growth stocks aren’t going out of fashion anytime soon, with Tesla often touted as one company in a core group that are leading the next wave.
Investing in growth stocks
Growth stock companies are hyper-focused on growing their market share as quickly as possible, often sacrificing short-term profitability in the initial phase. As such, growth stocks require a longer investment timeline to produce solid results.
This means that investing in growth stocks takes patience and conviction. Not only do you have to hold your investments until they rise in value, you need to believe that the company will meet or exceed its potential in the first place. Considering how nobody can predict the future, this is far easier said than done.
Also, because growth investing requires you to hold your stocks until their prices go up, you will have little liquidity or cash flow during your investment period. Bear in mind that your funds will remain locked up until you sell your stocks.
However, those who succeed in finding the right company, and sticking with it throughout the tumultuous growth phase, can look forward to reaping capital gains when they sell their stocks for a higher price than what they paid.
Who should invest in growth stocks?
Growth stocks are recommended for those who are looking to build up their wealth, and who have a long investing time horizon to achieve this. This is why some say that the younger you are, the better growth stocks are for you.
These types of stocks are also suitable for investors who do not require high liquidity in their holdings, or who do not seek cash flow from their investments.
Understanding dividend stocks
What are dividend stocks?
Dividend stocks are stocks that provide regular payouts to shareholders. These dividends are provided by the company issuing the stocks, and may come from profits, revenue, capital or other sources.
Dividends are more commonly issued by companies that have reached a mature or stable phase, where growth is no longer the highest priority. When this stage is reached, it allows a greater portion of revenue or profits to be freed up, which can then be offered as dividends in order to attract shareholders.
Alongside company equities, another popular type of dividend stocks is real estate investment trusts, or REITs.
Investing in dividend stocks
The premise for investing in dividend stocks revolves around building a passive income stream generated from the stocks you hold. Hence, you’ll want steady, consistent dividend payouts that continue as long as possible, ideally throughout your investment period.
As such, you will want to focus on financially sound companies that have proven staying power, and you will also want to keep an eye out for any upcoming changes or disruptions that could threaten the companies you have invested in.
It also follows, then, that you should avoid any companies operating in sunset industries, even if they are doling out high dividends. Afterall, there won’t be any more dividends to be received once the company collapses, taking the value of your stock holdings down with it.
Dividend stocks are not likely to provide high capital gains, but in return, are less sensitive to falling share prices. The dividends you have received may make up for or exceed any potential losses from selling, allowing you greater flexibility in managing your holdings.
Because dividends are paid out on a regular schedule, ranging from annually to quarterly, investors do not have to wait long to receive their first dividend payouts.
Who should invest in dividend stocks?
Dividend stocks are suitable for investors whose primary aim is cash flow and passive income.
The potential for capital gains through dividend stocks is lower, so it may not be the best instrument for those seeking to grow their wealth.
As how much dividends you hold is directly tied to the number of stocks you hold, dividend stocks work best for those who have the ability to buy a sizable number of stocks; often (but not always!) this means that dividend stocks work better for older investors who are more likely to have a bigger sum to invest.
Should you invest in growth stocks or dividend stocks?
Well, why not both?
Growth stocks and dividend stocks tend to be clustered around companies in different stages of the business life cycle, so including both in your portfolio helps you achieve some degree of diversification.
Another advantage of investing in both is that you can moderate the effects of macroeconomic factors on your investment. For instance, younger, growth-focused companies may be more sensitive to interest rate hikes, due to the increase in cost of borrowing such developments incur. Meanwhile, more mature companies may not enjoy as much upside from the emergence of new trends or changes in consumer behaviours.
As a general rule, younger investors should focus more on growth stocks to accumulate capital. As you get older, the focus should turn to reducing risk and volatility and achieving income, which is a role that dividend stocks can fulfil nicely.
It is important to remember that every investment decision comes with an accompanying opportunity cost, so it is worthwhile paying attention to your investments and conducting periodic reviews.
And needless to say, there’s no such thing as a surefire bet, whether you choose growth stocks or dividend stocks, so always only invest money that you can afford to lose. There’s nothing worse than being forced to sell all your holdings and exiting at a loss in order to meet an unforeseen emergency.
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