Growth Versus Dividend stocks: How Both Relate to Your Investment Returns
If you invest in dividend stocks, are you missing out on growth stock opportunities? Or does the income you derive from dividend stocks outweigh any opportunities you might be missing?
Understanding how you measure the return of your investments can help you make ideal decisions for your investment portfolio.
Measuring yield, simply takes into the account actual dividends paid by an investment over a period of time. Where total return is the sum of the income (interest and dividends) and capital appreciation generated by an investment. When evaluating a growth vs dividend investment strategy, you likely want to consider what type of investor you are and what you are trying to accomplish. In this blog post, we'll explore the differences between growth and dividend investing and how each relates to total return.
What Is a Dividend Stock?
A dividend stock is a stock that regularly pays a dividend to shareholders. The payment of a dividend can be in the form of cash or additional shares of stock. Some may argue that dividend stocks are a “safer” investment than growth stocks, as they tend to be mature companies with strong balance sheets and cash flow, who are committed to paying dividends. More conservative investors or those focused on income may prefer dividend stocks as they can provide more of a sense of assurance of a return due to their regular payouts.
However, do dividend stocks outperform growth stocks? It’s difficult to definitively answer this question as it depends on a variety of factors. Dividend stock prices tend to be more stable than growth stocks and may be less volatile. However, if you’re looking for long-term gains and the potential for larger returns, growth stocks may be the way to go.
What Is a Growth Stock?
A growth stock is a share in a company that is projected to grow faster than the market's average. This type of stock is typically characterized by its higher price-to-earnings ratios, lack of dividend payouts, and potential for greater long-term capital appreciation. Growth stocks might be more volatile than dividend stocks and tend to be less resilient during market downturns.
Growth stocks tend to be popular with investors because of their ability to increase in value over time. These stocks may not pay dividends, as their profits are instead often reinvested back into the company to fund research and development, expansion, and marketing efforts.
The performance of growth stocks depends largely on the performance of the underlying company. If the company performs well, its stock can increase significantly in value. On the other hand, if the company fails to meet expectations, its stock can drop substantially.
Dividend Stocks Vs. Growth Stocks
Dividend stocks and growth stocks follow two distinct investment strategies. Dividend stocks pay a set amount of cash on a regular basis, often quarterly or semi-annually, to shareholders. Dividends are typically associated with mature companies that don't reinvest all of their profits into their businesses. Growth stocks, on the other hand, may be associated with younger companies that reinvest their profits into growing the business. Ultimately, the answer depends on your individual goals and preferences as an investor. While dividend stocks may be a safer bet, growth stocks may present greater upside potential. To make the best decision for your portfolio, it’s important to consider your risk tolerance and investment timeframe.
What is Total Return?
Total return is the overall return on investment, taking into account both capital appreciation and income payments (dividends). It is a measure of the performance of an investment over a period of time, usually expressed as a percentage. Total return generally includes dividend payments, capital gains, and changes in the value of the investment itself.
Conservative investors who focus on yield often want to protect their principle and enjoy the benefits of the income it generates. Consequently, they often choose lower risk investment vehicles such as certificates of deposit, bonds, or money market accounts. But lower risk often means lower upside as well.
Investors who focus on total return often want to grow their portfolios over time. Of course, they want to preserve their principal, if possible, but their main objective is growth, not preservation. These investors often select high-growth funds or individual stocks.
Investment Growth as a Metric of Success
As an investor, you likely want to see your investments grow over time, whether from dividends or capital appreciation. After retirement, you may need those investments to continue to grow, while also wanting them to produce income.
Dividend stocks are generally known for providing a steady income stream, while growth stocks are more focused on capital appreciation. In terms of total return, both dividend and growth stocks can be beneficial to an investor’s portfolio. If your goal is to generate immediate income, dividend stocks could be a great option. However, if you are more interested in capital gains — which can be re-invested in income-producing assets later — then growth stocks may be a better choice.
Most often, our investment goals require some form of income, preservation, and growth. So, while there is no one-size-fits-all approach to investing, a total return approach that takes into account both dividends and appreciation may be beneficial.
How Do Dividends Affect Total Return?
Dividends can account for a meaningful portion of an investor’s total return.
Dividend stocks may continue to provide income during down markets, while growth stocks won’t provide this luxury. For this reason, you could find higher total returns during that time with dividend stocks.
Additionally, it’s important to keep an eye on how dividends may change over time. Dividends can be cut or even eliminated. They are not guaranteed. So if a high dividend yield stock seems too good to be true, that may very well might be the case. It could be a signal that the company is facing some business challenges that have decreased the stock price and increased the current dividend yield.
How Do Growth Investments Affect Total Return?
Remember that growth investments can have greater upside potential. They can add value to your portfolio as the stock price increases over time. This means that the majority of the return from growth investments is generally realized through capital gains as the value of the stock appreciates. When it comes to total return, growth stocks can potentially outperform dividend stocks over the long run if the value of the stock increases substantially. But again, greater upside potential, also often means more risk - that’s the price you pay.
As such, growth stocks tend to be more volatile and can have higher bankruptcy risk, so diversification can be incredibly important.
There is no guarantee that growth stocks will outperform dividend stocks when it comes to total return. Therefore, it is important to consider both types of investments when determining which one is most suitable for you. A mix of growth and dividend stocks might be ideal.
How to Use a Total-Return Approach for Retirement Income
When investing for retirement income, a total return approach can be beneficial. This approach considers both dividend and growth stocks. Both kinds of returns can be used to generate retirement income.
Imagine that each source of your retirement income is a colored piece in a pie chart. Your retirement plan should hold a lot of different colors. For instance, social security is one piece of retirement for many Americans. Other parts of your income plan might include a pension plan, employer-funded retirement accounts, self-funded retirement vehicles, and non-retirement investments. You might have a mix of stocks, bonds, real estate, or other investments in your chart.
Many investors tend to zero in on one or two of these pieces and neglect the others. For example, about 40% of retirees rely only on social security. Since social security replaces 40% or less of your working income, it will help keep you out of poverty, but it most likely won't let you live the way you want. Doing so would generally require a significant adjustment to your lifestyle, giving, or future care.
Other people invest in IRAs or 401(k) accounts, some with healthy diversification, others with a focus on high risk and some with a focus on dividend-paying funds. But hoping that high-risk investments will pay off or interest and dividends alone will pay for retirement might not be the best strategy. Here again, you could be left with little income despite an impressive savings record.
Consider that the S&P 500's average dividend yield is about 2.1%. That means if you have $1 million invested in a diversified portfolio that mimics the S&P 500’s, you'll get about $20,100 a year. For most Americans, that's not enough to live on even with a sharply reduced standard of living. Therefore, instead of focusing on one or the other (growth or income), look at both! Using dividend payouts and proceeds from selling stock over time may help provide the income you need. Not to mention, who wants to die with $1 million+ invested - remember, you can’t take it with you.
The best decision is the one that matches your investor type, circumstance, and goals. You and your personal advisor can work together to determine the best strategy for your retirement plan.
If you want to speak with a wealth management professional about starting or maximizing your retirement funds, give us a call at Cooke Wealth Management. We'd love to talk with you.