Every investor is searching for value, and both dividend and growth stocks have much to offer. However, the differences between the two are important to understand in order to ensure that your portfolio enjoys the returns that you are seeking.
Dividend vs. Growth Stocks: Understanding the Differences
Assuming that the underlying foundations of the company are sound, both dividend and growth stocks can be good investments. The crux of the difference between the two types of stocks boils down to the growth expectations for each.
Though many large, publicly-traded companies pay out dividends, this is not always the case. There are some who prefer to re-invest their revenues back into their businesses operations. Amazon (NASDAQ:AMZN), for example, has never paid dividends, instead using its profits to expand into new product lines and markets.
Therefore, dividend-paying companies are less likely to enjoy rapid growth. The value of dividend-paying stocks is that they can provide you with a regular stream of income, while at the same time generally keeping pace with the overall market trends. However, there are some notable exceptions to this rule, such as Apple (NASDAQ:APPL), which both pays a dividend and has outpaced the NASDAQ over the past decade.
Growth stocks, on the other hand, are expected to increase in value due to the growth of the underlying company. Eventually, growth stocks can turn into dividend-paying ones once they become more established and settled.
Dividend vs. Growth Stocks: Investment Goals
Dividend and growth stocks can each help you reach your investment goals, and it is important to define these objectives prior to entering the market.
Dividends are payouts that certain companies make to their shareholders, allowing them a share of the business earnings. These dividend-paying companies tend to be well-established businesses that are turning healthy profits, allowing them the ability to provide regular payments to their shareholders.
Because they are firmly entrenched in their respective industries, these companies offer investors a relatively safe destination to place their funds. The combination of regular dividend payments coupled with stable growth tend to make these companies part of a more conservative investment strategy.
Growth stocks, by contrast, are those which can be expected to outpace the market or other companies from within their own industry. They generally do not pay dividends, which meshes with investor assumptions that these companies will be more focused on growing their businesses instead of sharing their earnings with shareholders.
For this reason, growth stocks are for the more bullish investors, who are ready to take on more risk in the hopes of generating greater rewards.
Advantages of Dividend Stocks
The advantages of dividend stocks are that they can provide a regular source of income while their share price simultaneously increases in value.
Dividend payments are provided via cash or through dividend reinvestment plans, also known as DRIP. DRIP is an option that some companies offer their shareholders, whereby the proceeds of the dividends are automatically reinvested in purchasing more shares.
The benefits of DRIP for investors are multiple. First, they allow you to use your earnings to bring in additional revenues, providing you with a pathway to enjoy the magic of compound interest. Second, often times companies will allow their shareholders to purchase additional stocks at discounted rates, maximizing the reach of your cash.
DRIP is also a form of dollar-cost averaging, which is investing the same amount of capital in the same asset at regular intervals. This is a way to spread out the risk of purchasing assets at suboptimal price points.
Regardless of what you do with your dividend payment, however, it is considered taxable income.
TipRanks’ dividend calculator tool can help you understand the long-term benefits of dividend-paying companies, allowing you to experiment with different values and dividend-payouts.
Advantages of Growth Stocks
The advantages of growth stocks are mainly found in their potential earnings. Growth stocks are often less established than their dividend-paying counterparts, as they are plowing their profits back into their companies.
Dividends paid will not be used to invest in expanding operations, developing new products, or making inroads in new markets.
This is the inherent understanding of growth stocks: investors are willing to wait for an eventual growth in value as the business prospers, the share price increases, and maybe even one day dividends begin to be paid out.
Conclusion: Striking the Right Balance Between Dividend vs. Growth Stocks
Diversifying your portfolio is usually a wise investment strategy, and striking the right balance between dividend and growth stocks is no exception. While strategies such as a 60-40 investment portfolio will keep you well-balanced between equities and bonds, the stocks you pick are generally a reflection of your risk tolerance.
Those preferring a more conservative approach would do well to place more weight in dividend-paying stocks, which tend to be bigger, well-established firms with a history of turning profits. The prospects for significant growth are lower, but so are the risks.
On the other hand, growth stocks can be an attractive purchase for those searching for greater returns. These tend to possess a higher ceiling for growth, though this comes along with the requisite risk.
Understanding the difference between the two types of stocks is essential to making sure that your portfolio matches your investment objectives.
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