Investors use many metrics to pick stocks. Some pursue certain industries, for example, while others invest based on price changes and trends.One common strategy is to focus your trading on either dividend or growth stocks. With a dividend stock, you’re looking to make money off steady dividend payments over time. With a growth stock, you’re looking to make money off of a price increase and subsequent capital gains.Here’s how this works.
Reading articles like this can equip you to make good decisions about your money, but for professional help, work with a financial advisor.
What Are Dividend Stocks?
The difference between dividend stocks and growth stocks is based on how you emphasize each asset’s return, and how the company behind each stock plans for long-term growth.
A dividend stock is one that emphasizes regular dividend payments instead of the asset’s share price. As an investor, you plan to make the majority of your return off of these regular payments. Ultimately, when you do sell the stock, it will be a nice bonus if the price has increased and you make some money off the sale. However, by then you’ll have made the returns you planned for.
Dividend stocks are defined by the behavior of the underlying company. Here, the company behind the stock generally uses its profits to pay returns to shareholders. Again, that doesn’t mean the company exclusively uses its profits to pay shareholders. However, it emphasizes dividend payments in its corporate strategy.
Most companies make these payments on a quarterly basis.
When you choose dividend stocks, this means that you build an investment portfolio focused around dividend-paying assets. You should diversify this with some growth assets, but for most of your investments you will seek out stocks with a history of returns in the form of consistent, significant dividend payments. You might do this either by choosing individual stocks or by seeking out funds (mutual funds or exchange-traded funds) that invest in dividend-oriented assets.
Dividend investing means that you will have a more steady cash flow in smaller amounts than with growth investment, since these stocks make regular cash payments over time. If you pursue this strategy, you should also decide how you will manage the cash generated by dividend investments. Many investors roll their dividend payments back into their portfolio, either using the money to buy more of the same assets (allowing their investment to compound on itself) or they buy different dividend-paying stocks (allowing their portfolio to self-diversify).
What Are Growth Stocks?
A growth stock is one in which you emphasize growth in the stock’s share price over any other considerations. As an investor, you plan to make most of your money by selling the stock in the future. This form of profit is known as “capital gains.” It’s a nice bonus if your stock also pays some dividends along the way, but most of your returns will come from the growth in the stock’s price.
With a growth stock, the underlying company generally chooses to reinvest any profits in the business itself. By doing this it leaves relatively little money left over for investors, so dividends tend to be minimal. However, this reinvestment does tend to grow the value of the business over time. This, in turn, increases the value of the company’s stock.
When you choose growth stocks, this means that you build a portfolio focused around stocks which you expect to grow in value over time. You should diversify this with some dividend assets, but most of your investments will emphasize companies that reinvest their profits in themselves. This is a far less liquid strategy than dividend investing, because your stocks don’t generate any return while you hold them. Instead, you only see returns when you sell a set of shares and collect your capital gains earnings.
You might build a growth-oriented portfolio by choosing individual stocks or by seeking out funds (mutual funds and ETFs) that invest primarily around capital gains.
Growth investing means that your cash flow will be much more intermittent but in larger amounts than with dividend investing, since your money comes from selling these stocks in lump sums. If you pursue this strategy, you should also decide what you will do with the cash generated by each sale. Many investors roll their returns back into their portfolios, using the money to buy a new stock or set of stocks which they will hold in anticipation of future gains.
How Do You Choose?
While every investor needs to judge their own needs, dividend vs. growth investing generally can meet a few overall profiles.
Risk
Growth stocks tend to be higher risk than dividend stocks. In part this is because with a growth stock you are specifically seeking volatility. You want the stock’s price to change so that you can sell it for more money in the long run, but those fluctuations can cut both ways.
Dividend stocks tend to be lower risk than growth stocks. Companies which pay dividends tend to be well-established, so their payments tend to be steady and reliable. But dividend payments tend to be smaller than the money you’ll make off of capital gains, and by sharing their profits instead of reinvesting them these companies reduce their potential for stock price gains.
You can generally make more money off of growth stocks, but with higher risk.
Cash Flow
Dividend stocks provide their returns on a regular basis. As noted above, most companies pay dividend on a quarterly basis. Most companies also try to make similar dividend payments, or at least try to base their dividend payments on a regular formula. This makes dividends a good strategy for investors who need a stable and predictable cash flow.
Growth stocks provide highly intermittent returns. As noted above, when you invest in growth stocks you are trading on volatility. While you can set a target price at which you’ll sell your stocks, the market is inherently unpredictable. You have no way of knowing when (or even if) your stock will hit its target price. This makes growth stocks a good strategy for investors who can keep their cash tied up in the market in between sales.
Time Horizon
Growth investing tends to be a longer term model of investment. Ideally you will hold your stock for several months, if not several years, while it gains value before you sell it. This can lead to strong gains, but it means that you need to plan your portfolio, and your liquidity, around that kind of horizon.Dividend investing tends to be a shorter term model of investment. Since you are not trading a dividend stock for its long-term capital gains, you can move in and out of these investments fairly easily.
Generally speaking you will measure a dividend investment on a quarterly basis, since this is the time frame on which you will measure your returns.
The Bottom Line
Dividend stocks are equities that pay you a steady rate of return based on the profits of the underlying company. Growth stocks emphasize capital gains, with returns based on the share price gaining value.
Investing Tips
- One of the most important question when it comes to stock investing is what your time frame is. Are you looking for short term profits or long term holdings? Do you need liquidity, or can you leave your money tied up for a long time? It’s a good idea to answer those questions before you start buying assets.
- One of the best ways to sort through all the questions that naturally arise as you chose what securities to put into – and remove from – your portfolio is to consult with a financial advisor. Finding one in your area isn’t hard.SmartAsset’s matching tool can help you find a financial professional in minutes to help you answer questions about time, liquidity, risk and your overall personal plan. If you’re ready, get started now.
Photo credit: ©iStock.com/triloks, ©iStock.com/MicroStockHub, ©iStock.com/DaLiu
