When you want to get involved in the stock market, one of your top concerns is likely the amount of cash flow you’ll incur when you invest.
However, there’s more than one approach to take when investing, and you may wonder about the benefits of dividend investing vs. growth investing.
We’ll go over the definitions of growth and dividend investing, the key differences between both, the pros and cons of each and which option might work well for your particular situation.
What is Growth Investing?
Growth investing is a long-term growth investing strategy that focuses on investing in stocks that have growth opportunities. Put simply, growth investors look for stocks that could double their value (or more) in a few years if the company continues to grow. Your investment success relies on a combination of company expansion and success as well as the success of the stock market.
Growth stocks are sometimes called momentum stocks. When investors invest, they invest in large, well-established companies that they believe will overcome the stock market’s natural volatility over time. They often believe that growth stocks have metrics that prove their worth and market value. When you invest with growth in mind, you typically have a longer time horizon or at least expect your investments to grow in a specified amount of time. You anticipate that they will do that whether you choose to invest in ETFs, mutual funds or other types of funds. If you do your research, they will likely outperform the overall market over time because of their future potential.
Here’s an example of growth investing in action. Let’s say you had invested $1,000 in Amazon during its IPO in May of 1997. You held onto the investment, expecting it to grow. It would have been a great choice, as Amazon has managed to weather bear markets and achieve higher returns than most companies. Sure enough, you’d have more than $2 million today if you had invested $1,000 in Amazon during that year.
What is Dividend Investing?
Investing in dividend stocks simply means that you buy shares of publicly traded companies that pay dividends with the goal of earning a regular dividend payout at certain intervals. As your holdings gain value, you can also sell (or keep) your dividend-paying stocks for profit. Technically, you can also invest in dividend stocks and benefit from growth as well.
Here’s a dividend stock example. Let’s say you invest in a company that pays a 4% dividend per share. If you own one share of the company of shares worth $100, you’d receive $4 in annual dividends. These are called dividend payments.
Key Differences Between Dividend Investing and Growth Investing
Let’s take a look at the differences between dividend investing and growth investing by balancing some of the pros and cons. You can add more pros and cons to your list beyond the ones below. However, this list will get you started if you’re teetering between trying to choose between one or the other.
Pros of Growth Stocks
What’s the main reason most people invest in growth stocks? Sure, growth for the future is the main reason you may want to purchase growth stocks. However, let’s take a look at a few other opportunities:
- Stocks that have potential: When you find the right growth stock, you put yourself on an upward trajectory that will stay the course as a fantastic investment for years and years to come. Growth stocks are meant to be held for the long term.
- High-growth stocks: A growth stock investment strategy can result in quick increase in the stock price and a faster wealth accumulation than average companies. Growth stocks might even generate returns above the average gains in the market.
- Products and services may withstand competition: If a product is unique and needed, consumers will pay for it, meaning that it may offer a product or service that nobody else makes or does quite the same way. These are the types of companies you want to look out for because they could withstand the test of time.
Cons of Growth Stocks
Here are the cons of growth stocks and some reasons why you may not want to invest in growth stocks:
- Possible volatility: You can end up with the potential for more volatility than with other investments, particularly because an individual growth stock is not diversified. Growth stocks may swing more wildly than other, more diversified assets, such as an ETF fund that tracks the S&P 500 index. It’s important to have a high risk tolerance before you choose to invest in growth stocks. If you choose the right investment, however, you may come out ahead due to weathering recessions and other bumps in the road.
- Might not receive dividends: Investing in growth stocks does not automatically mean you’ll receive dividends — not all stocks are dividend growth stocks. Brokerages often offer screeners that tell you about the dividend opportunities you can get with each stock.
- Above-average growth is rarely sustained: Most companies are not Amazon. In fact, most companies fall back to a slower growth rate, which could lead to losses over a certain period of time.
Pros of Dividend Stocks
Considering dividend stocks? Let’s go over the pros of dividend investing before you get started.
- May offer dependability: Many dividend payers, such as the Dividend Aristocrats, offer guaranteed dividend income — cash flow that you can depend on. The Dividend Aristocrats are companies in the S&P 500 index that not only consistently pay a dividend to shareholders but increase the size of their payouts each year. A company can only become a Dividend Aristocrat if it raises its payout over the course of 25 years. You don’t have to worry about the whims of the stock market. Instead, you can pay attention to the dividend growth rate and not worry about trading or short selling stocks for profit.
- Reliable income stream: One of the most important parts of having dividend stocks at your disposal is that you can buy individual stocks but then expect a passive income stream to help you meet your monthly financial goals or carry you through retirement.
- Dividend fluctuation: Of course, not all companies return high dividends. If you invest in stable companies like Coca-Cola, you can reasonably assume that you’ll be able to take advantage of dividends well into the future. However, if a company has a bad quarter or goes belly-up on a merger, you could end up sacrificing dividends.
Cons of Dividend Stocks
What are the downsides of investing in dividend stocks? Let’s take a quick look:
- Investment risk: Compared to other types of accounts that have less risk, such as bonds, CDs and other fixed-income assets, dividend stocks carry more investment risk because of the nature of stocks, which aren’t well diversified — they’re inherently riskier.
- Exist in certain sectors: Dividend stocks are usually in specific sectors such as energy, financial services and consumer staples. These particular sectors may not mesh with your specific goals. If you have a long-standing desire for diversification or prefer to invest outside of those select sectors, it could cause you to compromise your selection options.
- Taxes, taxes: Dividends aren’t free. You must pay personal income tax on any dividends you earn over the course of a given tax year. Double taxation means you are paying tax both as a partial company owner and as an individual.
- High dividend yield isn’t always best: A dividend payout ratio shows how much of a company’s earnings are paid out to shareholders. However, sometimes the company’s payouts can be unsustainable and can result in a business having to cut or get rid of its dividends. Some corporations use dividends as part of a corporate strategy to allow investors to take advantage of dividends when its stock is a bit sluggish, but this might be a bad idea.
Which is Better: Dividend Investing or Growth Investing?
Should you opt for dividend or growth funds? Ultimately, it depends on the time horizon for your investments, your risk tolerance and returns you seek. Investors looking to create wealth for a longer-term horizon may want to invest in growth to enjoy extended returns. Your investment can multiply over the years.
On the other hand, you might use dividend investing if you’re looking for fixed and steady cash flow over the years. You may not be immediately concerned with total returns because you may prefer to rely on dividends.
No mutual fund or investment is absolutely perfect, but dividend investors may have options. Dividend stocks could be potentially less risky than growth stocks with non-dividend options because you’ll receive money at regular intervals. Both options give you liquidity, however, because you can sell dividend stocks and growth stocks quickly as well.
If you already have a brokerage account (such as with Vanguard or Schwab), you’re ready to invest in dividends or growth stocks. Choose the amount you want to invest, the stocks you want to invest in (making sure the fundamentals fit your needs) and purchase your dividend or growth stocks — or both!