For many people, the barrier to entry to investing is one that is hard to overcome. Perhaps they don’t have the money to start investing or they do have the money but have absolutely no knowledge of which assets they should buy. After getting over these initial hurdles, one question that typically pops into the mind of an investor is what investing strategy should I pursue? They ask, do I want to start building a dividend portfolio or a growth portfolio? This is an essential question to get right if you want to see incredible financial results so let me guide you towards the right decision now!
You’ve got your money right and are ready to take on the world of stock investing — congratulations. Whether you realize it or not, this one simple decision sets you apart from millions of other people. Hard to believe right? Anyone with even an ounce of financial education will know that the stock market is one of the primary drivers of wealth, especially when used correctly. However, as of 2021 only 56% of Americans said they own stock which means that literally over one hundred million people are giving up this golden opportunity. But, not you. You are ready to take the stock market by storm. The only question is, which type of stocks should you buy?
For most people, the answer to this question is buying what their Uncle Frank tells them to buy and as you can imagine this isn’t an ideal investing strategy. However, you probably already knew that! You see, most educated investors understand that there is a division in stock investing. You either invest for growth or invest in typically slower growing companies that offer regular payouts to its shareholders. Let me first define what both a growth stock and a dividend stock is so I know we are on the same page and then I will outline why you would want to invest in either one and finally what I believe is the best way to maximize your use of the two!
Growth Stock Basics
First off, what is a growth stock? A growth stock is any stock that is anticipated to grow at a rate significantly above the average growth of the market. Examples include Facebook, Shopify and Tesla. Now, you may be wondering how a company can grow at such a rapid pace and part of the reason is because they don’t typically offer dividends. You see, companies that want to grow as quickly as possible usually invest all their profits back into further expanding the business. This means that as a stock owner, you are literally banking on the fact that the company will appreciate enough from when you bought it to be able to see a nice return on your investment.
Diving into the pros and cons of this first investing approach, there is definitely a ton of potential to be realized when we look at growth stocks. In fact, these types of stocks can have the most substantial impact on your overall wealth because one good investment into a high growth company can make you abundantly wealthy. For instance, if you had bought Amazon or Tesla stock early in the game, you would have realized astronomical returns by now. Therefore, if getting rich as quickly as possible is your goal then you are probably better off investing in growth stocks than dividend stocks.
Now, with all good comes some bad and growth stocks definitely have their own set of challenges. First, if you want to buy into growth stocks, you often have to pay a hefty premium to do so. Because the company is trading based on anticipated growth, you are basically paying today what you expect the company to be worth tomorrow. One good example of this is Tesla stock. Many people believe they will be the frontrunners in electric vehicles in the future and as such have to pay for the privilege of owning that stock at an arguably overpriced amount now.
The second downside of growth stocks are the expectations that exist around them. Because people expect big things out of these companies, if they don’t perform, that growth you wanted to obtain may not come to fruition. You see, prices typically move with expectations and if a growth company doesn’t meet business targets and the like, then investors tend to panic sell which drives down the price. Therefore, with growth stocks, you have to understand that using these assets as a wealth building tool will be a rocky ride but if you get behind the right companies then great levels of financial success can be yours!
Dividend Stock Basics
Now, let’s talk a bit about dividend stocks. If you ask me, I believe there has been a major increase in popularity in dividend stocks over the past couple of years due to what I call the dream of “dividend freedom”. You see, I don’t think I am surprising anyone when I say that there are a ton of people who absolutely cannot stand the jobs they are in. To them, going into work every day literally eats away at their soul and as such they can’t wait to put together a financial escape plan and leave the working world altogether. For many, a sufficient dividend stream will be their savior and as such we see a ton of people striving to build up their dividend portfolios more and more by the day.
Now, this whole strategy will probably sound foreign to you if you don’t know what a dividend is so let me briefly get into that now. A dividend is a distribution of a company’s earnings. It’s kind of like a thank you offered to shareholders for having given the company their money. You see, when people invest in dividend producing companies, both the investors and the company win. The company wins because they gain access to more capital and more investments generally lead to higher stock prices too. For investors, having access to a quality dividend producing company means having the ability to collect a regular cash stream that many hope will be their ticket to financial freedom. So, with this being said, dividend stocks must be the holy grail of investing right? Not quite.
Besides the challenges of properly diversifying in dividend stocks and doing the research to try and figure out which stocks will continue to be regular distributions of dividends into the future, the main hang up I have with dividend stocks is the capital you require to see any meaningful returns from them. You see, many of the most popular dividend stocks like General Mills, Verizon and AT&T have had very stagnant growth for long periods of time now which means that the only way one benefits from holding said stock is through the dividend itself. This means that if you want to collect enough income from these stocks then you have to have a ton of capital invested. For instance, if you wanted to collect $50,000 a year from let’s say AT&T stock, you would have to have over $600,000 invested and for most people, getting to this level of investment without proper growth on their side is extremely difficult.
So, as you are probably coming to see, there is no perfect investment. With growth stocks, you will be tied to their earnings calls and will probably lose all your hair worrying about their upcoming corporate performance. As for dividend stocks, sure, they offer the dream of living off dividend income for life but for most people, this concept is more of a mirage than a feasible reality. With this being said, the two should definitely have their place in your investing portfolio however when and to what degree are the two questions we must answer. As I already mentioned, there are a ton of people these days who dread the thought of work. In their ideal worlds, they would have the ability to hand in their two weeks notice at work, tell off their boss and collect massive dividend checks for the rest of their lives.
Unfortunately, amassing a portfolio that will allow you to do this takes time and unless you are contributing major amounts of money into said portfolio on a regular basis then you will need the growth of high potential stocks on your side. This is why, in my opinion, younger investors are better off investing the majority of their cash into growth stocks over dividend stocks.
Now, I know I probably just stepped on the hearts of my fellow dividend investors out there but the reality is that it is too easy to fall into a low-growth situation with dividends early on in your investing career and leave a massive amount of profits on the table. Honestly, is collecting baby-sized dividend checks in your 20s, 30s and even 40s going to really move the needle for you financially? I can tell you that I would much prefer to see my portfolio skyrocketing in value through proper growth stock investing and becoming one step closer to amassing my financial freedom than collecting a $500 dividend check every quarter. Plus, if you are young and in the workforce, you should already have a steady source of income making cash flow from your investments less important now than it will be once you retire.
At this point, it probably seems that I am on team “Growth stocks” however, dividend stocks definitely have their place and we will talk about when this latter group of stocks will come into play. You see, as I just mentioned, as you get older, your income needs will change. This is primarily due to the fact that you will at some point want to put down your work tools and move onto the next stage of your life. Unfortunately, expenses don’t cease to exist when you retire so you will need enough income to keep you financially afloat. Hopefully, if you hitched your cart to the right growth stocks in your earlier years, you should now have a sizable portfolio to your name. However, should you still be focusing most of your investing efforts on growth stocks as you age? Probably not.
The “Perfect” Solution
We already discussed the downsides of growth stock investing and the risks that come with it. As such, to ensure you don’t overwork your pacemaker in your later years, you should ideally be moving some of your investments into more stable dividend stocks over time. For most investors, I think it’s okay to be predominantly invested in growth stocks in your 20s and 30s and with each passing decade you should shift 10% of your holdings out of growth stocks and into dividend stocks. Doing so provides you two main benefits.
First, by deferring those massive dividend checks you one day want to receive, you actually sidestep some unnecessary tax burdens. Think about it like this, if you are collecting dividend income while working, you are only further increasing your overall income and as such will face a higher tax owing compared to if you had not received any dividend income at all. Now, whether you are in the growth stock or dividend stock camp, I think both groups will agree that paying less taxes is a good thing.
The second benefit of slowly moving out of growth stocks and into dividend stocks is that you are able to lower your risk while still allowing your portfolio to grow over time. You see, I, nor anyone else wants to see you having to rejoin the workforce at 90 years old because your overly aggressive growth portfolio went belly up in your golden years. As such, you should be predominantly invested in dividend stocks in your later years to access the cash you’ll need to live while you maintain a position in some growth stocks that will allow your portfolio value to continue to rise over time.
Therefore, as you are coming to see, there truly is a time and a place for both of these types of stocks in your portfolio. When you’re young, investing in higher growth stocks should have your portfolio gaining at a rapid pace which will set you up for a nice transition into safer and more cash producing assets in the future.
One final point to note is that this split in the stocks you own is really only one piece of your investment pie. I believe that a well positioned portfolio will include many other asset classes like real estate, cryptocurrencies, commodities and the like. Therefore, continue to seek out attributes of assets you believe will help you achieve your financial goals and disperse your money amongst them to get the best of each!