Do you know who missed out on great growth stocks like Apple, Netflix, Google, Meta, NVIDIA and more over the last 10-20 years? Dividend stock investors. For younger investors (under 40), I believe it's better to invest mostly in growth stocks over dividend stocks. With growth stocks, you increase your chances of accumulating more capital quickly.
You'd rather invest in a company that is providing more capital appreciation while you are working. After all, earning dividend income is less important when you have job income. Instead, building as big of a financial nut as possible with growth stocks is more important.
However, once you are retired or close to retiring, you can shift toward dividend stocks for income. You shouldn't have as high of a tax bill in retirement due to a lack of W2 income. Further, dividend stocks are also relatively less volatile given their stronger balance sheets.
Dividend stock investing is a great source of passive income. In fact, I rank dividend stocks as a top source of passive income. The problem is, with dividend yields relatively low at 1-3% you need a lot of capital to generate any sort of meaningful income. Further, as a minority investor, there's no way to improve the dividend payout ratio.
Even if you have a $1,000,000 dividend stock portfolio yielding 2% that's only $20,000 a year in dividend income. Remember, the safest withdrawal rate in retirement does not touch principal. Further, you must ask yourself whether such yields are worth the investment risk.
Growth Stocks Over Dividend Stocks For Younger Investors
If you're relatively young, say under 40 years old, investing the majority of your equity exposure in dividend-yielding stocks is a suboptimal investment strategy. It's much better to invest in growth stocks over dividend stocks.
You're likely earning W2 income, so you don't need more income to pay more taxes with dividend stocks. Further, your goal is to build a large of a capital stack as fast as possible so you can be free sooner.
If you decided to invest in dividend stocks while you are young, you'll be hoping for filet mignon for decades while you eat Hamburger Helper in the meantime. When you reach your desired age for retirement, you might just be asking yourself, “Where the hell is the feast?“
Biggest Gains Have Come From Growth Stocks
Out of the few multi-bagger return stocks I've had over the past 20 years, none of them have been dividend stocks. Over time, dividend stocks will provide healthy returns. But if you are like me, you'd rather build your fortune sooner rather than later.
If I'm going to bother taking risk in the stock markets as a minority investor facing countless unknown endogenous and exogenous variables, I'm not playing for crumbs. When things turn south, everything turns south. Therefore, I want to be rewarded with higher potential capital appreciation.
Just know that when there is a downturn or a surge in interest rates, growth stocks tend to get pummeled much more than dividend stocks. Therefore, as a growth investor, you need to be able to withstand higher rates of volatility.
Once you've reached retirement, I suggest more conservative returns with dividend stocks. The last thing you want to do is lose all your growth stock gains in a bear market and have to go back to work!
Because despite the biggest gains coming from growth stocks, my biggest losses have also come from growth stocks!
Fundamentals Of Dividend-Paying Companies
The main reason companies pay dividends is because management cannot find better growth opportunities within its own company to invest its retained earnings.
The other main reason management can't find better acquisition opportunities with its cash. Hence, management returns excess earnings to shareholders in the form of dividends or share buybacks.
If a company pays a dividend equivalent to a 2% yield, management is essentially telling investors they can't find better investments within the company that will return greater than 2%.
Pretend you are Elon Musk, CEO of Tesla Motors (TSLA), a growth company that pays no dividends. Do you think Elon is going to start paying a dividend with its profits instead of plowing money back into research & development for new models with longer battery lives? Of course not!
It would be absolutely pathetic if Elon Musk could not beat a 2% return on its capital. Tesla Motors motors went public in mid-2010 and has been one of the best growth stocks of all-time.
Thank goodness Tesla did not pay dividends, otherwise, the company may have gone bankrupt. Raising debt and reinvesting cash flow back into the company is what made Tesla a successful growth story.
Dividend Stock Example
Now let's take a look at a telecom company like AT&T (T) which has the largest wireless network in America. Mobile phone penetration is over 88% in America according to Pew Research. AT&T also has the largest subscriber base in the industry.
The opportunity for accelerating growth is low due to the already high penetration rate. However, the cash flow generation is high since AT&T is like a utility that mints subscriber money in an oligopoly fashion. As a result of strong cash flow and no better investment alternatives, AT&T pays a fat dividend of ~$2/share, equivalent to a 7% dividend yield at today's stock price.
Just look at the comparison between Tesla Motor's share price in blue and AT&T's share price in green and there is no comparison. You can't even tell AT&T is in the chart. Over the past five years, AT&T is down 22.37%. Meanwhile, Tesla is up 2,340%. Which would you choose?
I'm a shareholder in both stocks and I regret buying AT&T for its dividends. AT&T stock has been a DOG! As growth stocks zoomed higher in a low-interest rate environment with high inflation and government subsidies, dividend stocks underperformed.
More Growth Stock Versus Dividend Stock Comparisons
Below is a chart that compares a 5-year price performance of growth stocks Google, Apple, and Facebook versus Dividend Aristocrat stocks such as AT&T, Coca-Cola, 3M, Procter & Gamble, and Chevron, and the S&P 500 index. As you can see, the difference in performance is large.
In a bull market, you want to overweight growth stocks in order to capture potentially greater equity returns. In a bear market, you want to be underweight growth stocks and overweight blue chip dividend stocks.
Collecting dividends is nice when you have a big portfolio and are near retirement. However, trying to grow wealth quicker through dividend stocks is a suboptimal decision.
A Misconception About Dividends
One of the main misconceptions about owning dividend stocks is that the dividend is free money. A dividend is not free money. Paying a dividend lowers the amount of cash on a company's balance sheet, which in turn, lowers the equity value of a company.
The only reason why a dividend stock tends to rebound after paying its quarterly or annual dividend is due to expectations. If a company has a history of paying a dividend, then the stock tends not to decline by the amount of dividend paid. Expectations are high that a company like Coca Cola will continue to generate enough cash flow to pay another dividend like it has for decades.
If the amount of growth cannot overcome the amount of value lost from a dividend over time, a company will likely decline in value. If you happen to invest in a company that is not growing and is cutting its dividend payout, then you've found yourself a real dud.
Growth Stocks Have Life Cycles Too
One of the greatest growth stocks in history is Microsoft (MSFT). However, even growth stocks like Microsoft can't always go up forever. Between 2000 – 2016, Microsoft's stock went nowhere.
If you were a young lad who decided to buy dividend stocks in the 1980s instead of Microsoft, you underperformed.
However, by 2003, Microsoft recognized that its Windows platform was saturated given it had a monopoly. Meanwhile, PC growth was stalling out too. Therefore, they started paying a dividend on January 17, 2003 because the company couldn't find a better use of its cash.
As a dividend stock, Microsoft was not bad with a 2% – 3% dividend yield for about a decade. The problem when you get big is that its harder to grow as fast anymore. Just look at dividend stock, IBM, which has essentially gone nowhere since 1999.
Thankfully for Microsoft shareholders, a new CEO revitalized the company and took advantage of the cloud and AI. Now Microsoft is a juggernaut and is considered a growth stock again thanks to artificial intelligence.
Growth Stocks Eventually Lose Their Mojo
Be aware of company life cycles. Not every company can evolve to take advantage of new opportunities, like Microsoft did. Tesla, Google, Amazon, and more growth stocks crashed back down to Earth in 2022.
How many companies did we know 10 years ago which are no longer around today due to competition? Many failed to innovate. Some faced massive disruptions in its business. Tower Records, WorldCom, Circuit City, American Home Mortgage, Enron, Lehman Brothers, ATA Airlines, The Sharper Image, Washington Mutual, Ziff Davis, Hostess Brands and Hollywood Video are all gone!
This is why you cannot blatantly buy and hold a stock forever. You've got to stay on top of your investments at least once a year. Most growth stocks gave up all their 2021 gains in 2022 as the Fed aggressively increased rates.
In 2023 and 2024, growth stocks have come back with a vengeance. As a growth stock investor, you must sell stocks on occasion if you would like to enjoy your gains. Given growth stocks usually don't pay dividends, selling stock to pay for life is the only real way to enjoy your returns.
Dividend Investors Should Pay Closer Attention To Interest Rates
In a rising interest rate environment, dividend-yielding stocks, REITs, and bonds tend to underperform the broader market.
In a declining interest rate environment, as long as dividend-paying companies are continuing to generate good cash flow and maintain or increase their dividend payout ratio, they will be seen more favorably. Dividend-yielding companies look relatively more attractive as interest rates decline.
Long-term, we will likely be in low interest rate environment. However, inflation is high thanks to huge amounts of stimulus post pandemic.
As a result, blue-chip dividend stocks should outperform growth stocks in a high interest rate environment. Only when the Fed starts pivoting / cutting rates, will growth stocks return to favor.
When interest rates are low, companies can borrow more debt more cheaply. If a growth company can borrow debt at 2% and invest the money to grow its business by 10%, a growth company will outperform a dividend company.
In a low interest rate environment, investors may wonder about management's acumen of continuing to pay a high dividend yield when they don't have to. Once again, growth stocks win.
In a higher interest rate environment, dividend stocks outperform. Dividend-paying companies generally have stronger balance sheets and steadier cash flow. You may want to buy Treasury bonds in a high interest rate environment as well to earn risk-free returns.
“Dividend Growth Stocks” Is A Misnomer
Some people like to think they are investing in “dividend growth stocks.” Sadly, this is unlikely to be true. The words “dividend growth stock” are an oxymoron. The larger a company's dividend grows the more it means management cannot find better use of its cash.
Again, management is trying to optimize the best use of capital. Since capital is limited, over the long term, a company can't pay more in dividends if it finds better growth opportunities elsewhere. Sure, dividend stocks can certainly grow, as many have. But they don't perform nearly as well as growth stocks during a bull market.
Everything is relative in finance. A “dividend growth” investor may see 8% profit growth in one year as very enticing. However, a growth stock investor may be looking for at least 20% profit or revenue growth a year.
To help you better understand the dilemma between paying a dividend or reinvesting your company's cash flow, pretend you are the CEO of a company. Your goal is to maximize the return of every dollar spent.
How Much To Invest In Growth Stocks By Age
Let's say you agree that it's better to invest in growth stocks over dividend stocks when you are younger. Let me share a guide for how much to invest in growth stocks by age.
These percentage figures for investing in growth stocks are for your stock-specific investments, which is a portion of your overall active and passive stock investments.
In other words, let's say you have a $1 million investment portfolio. You decide to invest $600,000 in equity index ETFs like SPY and $200,000 in bond index ETFs like IEF. The remaining $200,000, or 20%, will be invested in individual growth stocks or dividend stocks. This is the portion of your investments we're talking about.
Growth vs. Dividend Stock Weightings
Age 0 – 25: 100% growth stocks, 0% dividend stocks
Age 26 – 30: 100% growth stocks, 0% dividend stocks
Age 31 – 35: 90% growth stocks, 10% dividend stocks
Age 36 – 40: 80% growth stocks, 20% dividend stocks
Age 41 – 45: 70% growth stocks, 30% dividend stocks
Age 46 – 50: 60% growth stocks, 40% dividend stocks
Age 51 – 55: 50% growth stocks, 50% dividend stocks
Age 55+: 40% growth stocks, 60% dividend stocks
In my opinion, it's always good to invest some percentage of your stock investments in growth stocks. However, as you get older and wealthier, you likely want to take less risk, experience less volatility, and earn more passive income.
Further, since dividend stocks pay dividends, you will also have to pay taxes on the income. If you so happen to already be earning a high income thanks to your day job, earning more dividend income is suboptimal, despite dividends getting taxed at a lower rate.
Your Main Investments Are Already Generating Income
Remember, your main index funds and ETFs should generate the bulk of your stock and bond passive income. Therefore, investing in more dividend stocks with your stock-specific investments may not move the needle. Instead, you might as well invest in growth stocks that will hopefully provide you stronger capital returns.
However, in a bear market, low beta, dividend stocks will likely outperform growth stocks as investors seek income and shelter. Once you've grown a sizable financial nut, your goal should shift more towards capital preservation.
My recommendations for investing between growth stocks and dividend stocks by age is just a guide. If you are more risk-loving, then you can certainly invest a greater percentage of your stocks in growth stocks and vice versa.
Just remember, you've already established a proper net worth allocation by age. My base case scenario in the second half of our lives is to have roughly a 30%, 30%, 30%, 10% split between stocks, bonds, real estate, and risk free investments. If you follow such a net worth split, then you already have a healthy amount of assets that are paying you income.
You're only investing a minority of your investable assets in active investments. Therefore, you might as well try to see if you can outperform the most with growth stocks in this bucket.
Growth Stocks Versus Dividend Stocks Recap
Let me summarize why I think it's better to invest in growth stocks over dividend stocks for younger investors (<40).
1) It's harder to build a sizable financial nut with dividend stocks quickly.
Management is returning cash to shareholders instead of finding better opportunities within the firm to invest. Therefore, by definition, a dividend-paying company's growth is anchored by its dividend yield.
2) Dividend stocks tend to outperform in a rising interest rate environment.
Think about what happens to property prices if rates go too high. Demand falls and property prices fall at the margin. However, in a low interest rate environment, growth stocks tend to outperform. The reason is because cheap money can be borrowed to reinvest in faster growth opportunities.
That said, dividend stocks don't always outperform in a rising rate environment. Since the pandemic began, notice how DVY (iShares Select Dividend ETF) has underperformed SPY, the S&P 500 ETF. However, if we were to overlay QQQ, the NASDAQ ETF featuring growth stocks, the outperformance would likely be even more significant.
3) Understand your passive investment income composition.
If you properly diversify your net worth you will already have a good portion of your net worth producing a steady stream of income through real estate, bonds, CDs, and other income producing assets. Adding dividend stocks is therefore adding more to fixed income type of assets.
4) Match your investment style with your stage in life.
It is backwards to aggressively invest in dividend stocks when you are young when you've got little capital. When you are young with a little amount of capital, your primary goal is to build as much capital as possible.
When you are older with a lot more capital, investing in dividend stocks makes more sense. You want to generate income as a retiree so you don't have to work. Further, you become more risk-averse because you have less time to make up for your losses.
Investing in dividend stocks once you've built a chunky capital base is a more optimal move. In general, dividend-paying companies have strong cash flow, larger balance sheets, and more defensible moats. These are all good attributes for older investors looking for more steady returns.
5) Bear markets crush growth stocks more.
If you think we are heading into a bear market, you will likely lose less investing in dividend stocks over growth stocks. Dividend-paying companies tend to have stronger balance sheets, stronger cash flow, and more defensible business models than growth companies. However, if you think a really nasty downturn is on the horizon, rebalancing out of equities may be an even better strategy.
Growth stocks get crushed during bear markets. Hence, for the love of god, please don't buy growth stocks on margin. Not only might you lose all your money, you may also lose your reputation and the respect of your friends and family.
6) Think like a CEO or CFO when deciding between investing in a growth stock or dividend stock.
To help make your company a success, you must find the optimal use of each dollar. Using your company's cash to pay a dividend means the alternative of reinvesting the cash into your company or acquiring new business aren't as attractive.
You are free to invest in whatever type of stock you like. We all have different financial goals and financial situations. However, I hope you at least find the logic in my arguments.
A Powerful Investing Strategy To Consider
The final investing strategy to consider is buying growth stocks and investing in real estate, instead of dividend stocks. This powerful combination provides the best of both worlds: growth and income.
I've invested in growth stocks and dividend stocks since 1997. Growth stocks have, by far, provided the most amount of returns since college. What I've also consistently done with some of my growth stock winnings is reinvest some of the proceeds into real estate. I've also used my savings to expand into real estate as well.
Real estate tends to provide more income than dividend stocks. Real estate also offers asset class diversification to dampen volatility. During stock market downturns, real estate often outperforms, as we saw during the March 2020 meltdown. I don't enjoy seeing the value of my stocks go *poof* overnight. But I do like the steadiness real estate provides.
Although managing real estate is more of a hassle than investing in dividend stocks, I like the diversification. Further, by investing in private real estate syndication deals, I no longer have to deal with tenants or maintenance issues.
Favorite Real Estate Marketplace Platforms
I've personally invested $810,000 in real estate crowdfunding across 18 projects. My goal is to take advantage of lower valuations in the heartland of America and earn income 100% passively. Real estate crowdfunding investments and rental properties have supplanted my dividend stock investments.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and manages over $3.5 billion for over 500,000 investors. The company invests primarily in the heartland where valuations are lower and yields are higher. For most investors, investing in a diversified eREIT is the way to gain real estate exposure.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities have potentially higher growth as well due to job growth and demographic trends. If you have a lot of capital, you can build your own select real estate fund with CrowdStreet.
I plan to continue investing in growth stocks and real estate for the foreseeable future. Both platforms are sponsors of Financial Samurai and Financial Samurai is a six-figure investor in Fundrise funds.
Invest In Private Growth Companies
In addition to investing in growth stocks and real estate, consider investing in private growth companies through a venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
One of the most interesting funds I'm allocating new capital toward is the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 75% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Dividend or Growth Stocks is a Financial Samurai original post. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.
I read recently that Apple has abandoned its Apple Car project after spending more than $10 billion since its starting the effort in 2014. Apple is almost everyone’s idea of a growth stock. I own it as both a direct investment and in various index funds.
But the idea that fast-growth companies always know best how to invest their cash is put to the lie by this story in the New York Times. https://www.nytimes.com/2024/02/28/technology/behind-the-apple-car-dead.html
Indeed, there’s a strong argument to be made that regular and rising dividends keep management disciplined on the business at hand rather than chasing bad development projects like the Apple Car or ill-conceived mergers and acquisitions. We can all think of companies that went on an acquisition spree only to sell their acquired companies for pennies on the dollar a few years later.
As an investor, I would have much rather preferred that Apple would have put some of that $10 billion back into my pockets via dividends.
As always, thanks for your writing. Shouldn’t the debate be between growth and value though? I understand that most high yielders fall into the value category, but what constitutes a value stock is more than just the yield, specifically it’s valuation.
One of the things you pointed out was that younger people ideally would be more concerned about larger gains in their early years versus lower risk/lower volatility. What isn’t mentioned is that value stocks over the longterm have outperformed growth. So if we’re concerned about longterm gains, wouldn’t a good value fund be more ideal?
Hi Sam. I just wanted to say that I totally agree with your point on growth investments and dividend investing is just a tool people use to feel more comfortable about the ups and downs of the market even though dividends aren’t guaranteed. HOWEVER I do think there’s one thing that people miss and that is that as a retail investor you can use stop losses (we can get out of a stock in seconds unlike institutions) and technical analysis to limit risk and time the market at the same time as using fundamental analysis to pick growth stocks. No one needs to sit through a 30-50% drawdown in their portfolio and by using the tools mentioned above, you drastically reduce your downside risk whilst taking advantage of the upside in markets like the one we see today.
Love your work.
Ben
There is a growth fund, that screens for PE, return of equity,
and leverage… the S&P 500 GARP fund. (Growth at a Reasonable Price).
Ticker SPGP.
Less volatile, and more defensive than other growth funds.
Thoughts about GARP investing?
Great article, thank you.
While growth stocks are a great way to try to maximize your returns on the stock market, the chance of failure is also high.
What do you say to everyone who lost more than half their investment portfolio this year?
Dividend and index investing are not sexy, but at least you will survive market volatility and be sure your portfolio will do well in the long run!
Using stocks like Tesla as an example is fine, but how many other growth companies go bankrupt or don’t make it?
Hi – Thanks for the great content. In your $1,000,000 example you mention an 80/20 split between stocks and bonds. Is this example strictly for stocks and bonds only? In you Net Worth Allocation article, the overall investment splits are different by age when real estate allocation is included.
Thank you,
Jeremy
This was very well written and just what I was looking for. I am now 56 and often help newbie’s with investing strategy. Too many want to do their own but don’t want to watch their stocks. Sorry, but everything can be cyclical, if you don’t want to watch, have someone professional do it for you. One other comment…or question really, especially for IRA’s, don’t you think you can find growth stocks in certain areas like Real Estate and Commodities. I often move my money to stocks like OIL STOCKS or NATURAL GAS stocks when prices go up. I often get rewarded with growth and excellent dividends, but I do get out when prices start to drop. Again, thanks for the article….50% 50% for me
Just a minor comment on one thing you say: to check out Fundrise and “Investing in a eREIT or real estate ETF is the easiest way to gain real estate exposure without leverage.”
To clarify, you can buy into Fundrise with cash, i.e., without *personally* taking on leverage, but Fundrise itself uses leverage, which means that shareholders are indirectly taking on leverage, and all the risks that go with it. I don’t say that as a criticism, because for the most part that leverage has helped to accelerate gains over the past several years. I’ve been investing with Fundrise since early 2018, and like the company very much.
Yes indeed. It’s up to Fundrise to figure out how to structure their investment purchases. In general, I like investing in a fund rather than individual investments for more simplicity and less volatility.
Hello,
I am almost 40 years in your opinion should I still invest in growth stock?
Hi I have to say the most important thing in the game of investing is understanding the business you have invested in. I think investing in dividend stocks vs growth stocks should come secondary. People should not invest in something they don’t ultimately understand in.
This is probably the most important factor in succeeding in investing avoiding the lemons of the stock market. Unfortunately this may mean missing out on great growth stocks for example Amazon lost something like 70% of its value from 1999 and took 8 years plus to return back to original value. However the irony is even its peak value at 1999 seems absurdly cheap now. Although I will put my hand up and say I could never have anticipated how the business would develop.
For this reason I would have stick with the stodgy dividend stocks despite being in my 30s
Thanks for this insightful article. I do agree with the notion of investing more in (early) growth when your younger. It’s indeed much more easier to recover from any mistakes while the likelihood of having outpaced SP500 returns is much higher.
I’m a bit later and I invest for income. Real Estate sounds interesting, but it’s really not that much of an option over here where I live in Europe. Rental yields are so low that i can better invest in US Real Estate Investment Trusts.
They give better yields and I can sell them on the post. It also saves a lot of notary and other transaction costs.
Have a great day!
Nice article. But I always get a little “unsettled” if a theory gets “substantiated” by using single examples like the magical Tesla, or Microsoft, or even GM. Just because Tesla does “this”, or Microsoft has had “that”, doesn’t validate a theory. I recognize the potential in growth stocks but not all growth stocks have delivered their promises either. (!!) We like to hear about that rogue investor who quickly became a millionaire but you hear seldom of those investors who bankrupted themselves. And certainly it isn’t always true that a company that pays out a conservative dividend has an executive board sitting with their hands in their hair because they haven’t got a clue what to do with their earnings in terms of growth. I prefer to invest in companies that are known to have a healthy balance sheet and pay a CONSERVATIVE dividend. Now this may not make me a multi-millionaire but in terms of gambling, I think this is a safe bet for a conservative investor, like me. And while dividends are taxable, so is the capital gains if you sell stocks at a profit.
Sure, I get it on single examples. And perhaps I should have also included holdings like Netflix, Google, Amazon, Nvidia, etc.
But I hope you and others do digest the reasons for why I think younger investors should invest in growths stocks, and why all investors should allocate some portion of their stock portfolio to growth stocks.
I see things more clearly now as a business owner who finds growth to be difficult, but who appreciates growth by any company who can continue grow.
Thanks for the prompt reply!! And yes, portfolio balance (depending on age) is the key. I am not that young anymore (and certainly not that experienced as some of you out here) and thus I emphasize more on dividend stocks of reputable companies that have solid history nothing to be ashamed off. I also don’t have huge amount of monies lying around that I can take a big risk. One advantage I have at least is that I work in academia and thus my pension is lifetime (for me as well as my surviving spouse). Whatever I earn out of my portfolio is just “extra”
With a pension, you have certainly hit the jackpot! Any irony is, with pension, you can take more risks if you want to.
People in the private sector do not recognize the value of a pension as much as they should.
See: https://www.financialsamurai.com/how-do-i-calculate-the-value-of-my-pension/
Great article. I glanced over it but will dig into it a bit later. Peace!
Unfortunately, in Belgium, dividend stocks aren’t really interesting. It’s much more interesting to invest in accumulating trackers or stocks that don’t payout but rather reinvest their profit.
I think there is a major failure for many people in the assumption that a dividend stock can not also be a growth stock. Price appreciation can easily happen while a company is paying a dividend. In fact there are many stocks out there that have been the S&P 500 over a ten year period. Now do they outpace a company like Tesla? No, but they do provide a great return on top of the compounding effect of a dividend.
I also think that paying a dividend does not mean a company is not reinvesting in itself. If a company has a wide moat and good financials, that remaining free cash flow can be put to great use outside of just supporting a dividend. I think one of the major problems people have with dividend stocks is they expect them to work like a growth stock and yield chase. This typically means they end up with lower quality companies, or companies more suited for a retiree to generate monthly income.
What you outline here is really smart and are some of the pitfalls I see so many people complain about when they get into the markets.
How have your dividend stocks done compared to growth stocks? And how long have you been investing? It’s just good to know where you’re coming from so we have a better idea.
There are definitely benefits of dividend stocks and dividend stocks can definitely perform well as sell. I have plenty of dividend stocks as I head into retirement again. But I have already accumulated my nut.
Gl on your dividend stock business.
I am nowhere near as seasoned as you are as an investor and I have a ways to go; it hasn’t been quite a decade yet for me. I started my journey focused on growth because I still had plenty of time in the market. But I discovered that I didn’t need to maximize my gains to the extreme and that I was happy if I could formulate a strategy that helped me stay above the total market index’s so there was a reason for choosing single stocks over a broad market ETF.
I think with growth stocks you are always going to have the opportunity to really maximize your wealth accumulation short term, but for longer term investors I think if you find dividend stocks with strong growth factors you can benefit from maybe less price growth that is offset by compounding factors from reinvestment. I think all the points you make here are on the nose and I agree, I just see so many people entering the market now thinking that they are going to “make millions” on a stock pick, but are missing the real art of what it means to invest and the research it takes to know that you are finding a solid company and not just a fleeting internet fad. I really love that you do not show a real preference here really, both forms of investing have their pitfalls and the reality of investing can be rough for someone who isn’t willing to put in the work if they are doing it on their own.
Also, thank you for the well wishes. More of a passion project than a business, but I hope it can help people along the way as a free tool. I have known of your site from some time and have taken inspiration for how many great resources are out there from people just trying to help.
The great thing about investing is that everything is rational. We invest in what we feel right. And then we accept the outcome, 5, 10, 30 years from now.
Sounds like you are in your late 20s or early 30s? It’s hard to know what you don’t know. And as you get older, you’ll find out there’s even less you don’t know! But good thing time is on your side.
The stock market has a way of humbling all of us. Always stay flexible in thought.
That is the best advice. It has been a pleasure.
Hi Sam,
Love the topic and your views on dividend vs growth.
Probably a couple of comments from me, a non American investor:
-A stocks value can always go to zero. Growth stocks crash. At least with a dividend you have a payback period. I think about dividends being money off the table, a slow de risking of the invest. I mean payback period is also an important financial metric?
-We are all dead in the long term.
-It also depends on what you want to do with your dividend. I for instance like toggling between reinvestment/ buying more shares / reducing debt. That optionally is really compelling, especially in a bear market with a portfolio that produces cashflow. Alternatively in a market that *may* be overvalued. Cash is king.
-Ideally a company will have low debt, which being an obligation to pay may lend itself money to pay shareholders rarther than bond holders with some safety. I tend to value a consistent payout ratio on mature companies with reasonable future prospects.
-Strong growth stories are hard to find, as are reliable dividend payers but the two are not mutually exclusive. It’s possible to have both.
Just 2 bob from me.
Great article and am in 100% agreement. I’m a growth stock girl. You have to think beyond the quarter, beyond the year, and grow long-term with these companies. It’s a huge benefit! Stick with them. I also own a few dividend stickers, and take the dividends and plow them back into growth stocks.
Thank you!
I’m heavily weighted in a dividend-producing fund in my Roth IRA, specifically. I believe dividend-producing funds or stocks are invaluable for early investors because over time, you actually own additional shares with reinvestment, whereas rising stock prices and gains is on paper only unless you cash out. Paper gains can be wiped out real quick with a crash and I think one is inevitable.
I’m weighted about 8-10% of my total retirement allocation in small caps though to ride the growth you discuss.
I didn’t really consider the future of our interest rate environment (which seems forever up in the air) and how that could affect firms offering dividends so thanks for the reminder.
Cool. Hopefully you are in the middle or second half of your financial journey. It’s great to have less volatility in a large portfolio the produces income to provide for desired living expenses.
To be able to minimize heart attacks by wanting less at an older age is great.
Great post, Sam! The most important sentence in the entire post is- “Paying a dividend lowers the amount of cash on a company’s balance sheet, which in turn, lowers the equity value of a company”. I wish people understood that dividends also have an opportunity cost. What if the company used that money to invest in better NPV projects?
During my MBA program, I took a course titled Advanced Corporate Finance, and our professor explained this concept very well using the example of Microsoft.
Fortunately, he has made his course available for free online, and the curious mind can go and read more about this concept here: janschneider.website/teaching/corporate/10_dividends.html
@Tarun – my young friend, I suspect that the MBA theories and the nice, cut from reality graphs that come with them will not bring wealth to most people. Your professor giving you as example Microsoft is the epitome of what’s wrong with all these paper tigers. Why didn’t he use GE as example? Or if his point was to be more modern – why didn’t he use TSLA? Do you have a proof that the “hot” TSLA will make many new millionaires in the long term? Even a kid can look at graphs post-factum and build whatever theories he can imagine. The truth is – no one can predict the future and this is where the big problem for real people lays.
Sam is right in his theory of investing entirely in growth while you’re young but only with some assumptions and unfortunately assumptions is what makes an “ass” from “u” and “me”. He admits that later on in life you should add dividend stocks but he fails to explain how exactly should this magic happen – are we talking here about moving funds from growth to dividend later in life (for success in such strategy you obviously need to be really lucky in timing the market properly) or most of the new funds you invest later in your life should be directed towards dividend stocks. This is a crucial point if you want to create a theory and it’s not answered here. I wonder why. If he’s talking about the first, only few lucky ones will manage to do it but the majority will fail measurably trying. The biggest culprit of investing all in growth when you start investing is that growth is much more unpredictable and volatile short term than investing in dividend and compounding it. Unless you’re lucky, investing all in growth for a period of time will most likely burry you long term and even if the idea is that at some point of time you’ll start putting more new money towards dividend, this might not offset the potential loses from investing fully in growth till that point.
Now comes another essential question – are you the really selfish type of person who doesn’t care about his kids and wants to spend all he managed to accumulate over the years or he wants to leave some sort of financial legacy? If it’s the later, investing too much in growth is a real disaster. All you can leave behind that has some sort of control are dividends, not growth. This is because dividends are much less volatile long term in general than growth and if one needs X amount of money per month, he cannot really afford thinking what the market is doing this month and if his or his great “papa” picks are still growing this month. Only dividends can give you the freedom to not touch the principal this month – again, because dividends are much less volatile than growth. If you can create a portfolio that let’s you live off of only dividends, you’re in much better control of not only your future, but the future of your kinds as well…
Just think it really through before you get too excited about growth theories and nice professor’s graphs…
Just a random guy browsing the internet here…
Mike fails to understand the risk to reward ratio. If you have a few mil in the bank and want a hands-off (risk-free) income, put it into dividend stocks.
But what if you don’t have a few mil to invest?
This is where the risk to reward comes into play. Yes, you can build up your dividend portfolio and reinvest dividends until u ready to retire (a very safe but slow strategy). Also, each time you collect dividends, you pay taxes. Why would you collect a dividend to pay taxes and turn back around to reinvest into the same portfolio (facepalm here)?
Instead, the goal for the young person would be to get to the few mil portfolio as fast as you can. One of the ways to do so is to buy and hold growth companies like Tesla. You want to dca into your top 3-5 picks over the next 10-15 years. This is what true compounding is all about. It’s not about taking money out every year.
Everything in this life is about the risk to reward ratio. Most people would eliminate risk to feel safe, but the reality is that the more risk you take the more successful you will be.
If you are feeling fancy, you can go day trade some options to take as much risk as you can, you might get rich quick ;)
Growth stocks would be a happy medium for someone who wants 20-50% (sometimes even more) annualized returns and educated enough about their stock picks. Sure, the stocks might crash, but if you don’t sell and just hold it thru the bear market, you will most likely come up ahead in the new bull market.
If you want to grow slow and steady and retire at 60 with 100K/year dividend, go for it. I want to do the same but when I am 40.
Does the time worth the risk?
It’s up to you, but growth stocks will always provide a faster and better return than dividend stocks.
Paying a dividend does not affect the enterprise value of a company, it lowers the equity value.
Enteprise value = Equity value + Debt – Cash. The dividend payment lowers cash, so enterprise value goes up. But the dividend payment also lowers equity value by that same amount, so enterprise value doesn’t change. (Enterprise value roughly represents the operations of the company and debt / cash are just capitalization changes).
You also don’t have to take his word for it. Empirically, dividend stocks outperform. From 1972-2017, dividend stocks returned on average 9.25% p.a., and stocks without dividends returned on average 2.6% p.a. If a stock stops paying a dividend, it’s very bad as the article mentions, and those stocks underperform. But while there are big winners like amazon, growth stocks underperform on average.
Perhaps the biggest argument against dividends is the inefficient tax nature of it, and instead would be better off with stock buy-back programs which allows investors to time their dividends appropriately. Also you have more chance to be a millionaire with growth stocks by getting “lucky”. But most will just underperform their dividend peers.
Sam,
I always look forward to your articles because they get me thinking about the best ways to allocate my investments. Straying slightly off topic, but while reading this post I began thinking about this: I wanted to ask if you have ever written an article about best investment strategies (dividend stocks, growth stocks, REITs, tax free munis, bonds) for different types of accounts (401k/IRA, Roth, post-tax) based on the taxes applied to the different account types?
Thank you for this article. From your other articles, I had come to the conclusion that maximizing income was important, and that dividend stocks were a way to increase income.
Having said that, though, I agree with the gist of this article. I have been investing for a short time, but I realized recently that by using dividend stock strategies only, it would take forever to get to financial independence. I realized that a “money printing” strategy was also needed just to get the sheer number of dollars up, dollars that could then be used to produce dividends and other passive income.
Since I don’t have a finance job, am not an executive, and have substantial household costs, the dollars from my w2 income go to lifestyle and there is only a limited amount available for investing. Investing in growth stocks to grow the number of dollars, and then moving them to dividend stocks to grow the passive income, is my current strategy.
Thanks for the articles, they make me think and consider new perspectives!
Great! You’re welcome. And actually, the value of dividend income has also gone up with interests rates having come way down.
It’s just that in a bull market, dividend stocks investing is a suboptimal way to build wealth versus growth stocks.
I tend to agree the younger you are the more chances you should take. However, if you invested any money into T exactly 10 years ago today and reinvested your dividends your annual return is 6.08 percent. Not Tesla money but not bad either. I think younger people should look at dividend stocks more as bonds with a higher potential for appreciation.
Comparing Tesla to T is to extreme. How about Intel compared to McDonalds.
For sure. People said the same thing in 2015 when I compared Tesla and AT&T. Now the difference is even more pronounced.
A 6% compound annual return is nice for sure. However, everything is relative in finance.
I wish I would’ve listened to you in 2015!
Tesla gets you rich, T keeps you rich:)
Hah, I wish I listened to myself and went all in on TSLA back then too!
Oh well. Back to the salt mines of writing posts!
I mostly agree. Young investors should invest in growth stock. However, it depends on your track record too. I invested in growth stocks in my 20s and didn’t fair so well. I sold too early and owned too many bad stocks. Life became much easier when I changed to index investing + dividend stocks.
My main problem with growth stock is their share buyback programs. They always invest badly and buy back when share price is high. IMO, dividend is much better than share buy back. If they can’t invest wisely, give the money to the investors.
I wish I understood this stuff when I was a young investor. But at least I tried, saved, and put money into the markets. I could have made a lot more if I focused on growth stocks but I really didn’t know what I was doing. C’est la vie. At least I plan to teach my kids as much as I can about investing to help them out as much as possible
I feel like a logarithmic graph is underutilized in comparisons like this. Look at DIS vs. TSLA. DIS gained 79% in that timeframe, which is pretty good, but it looks as flat as EXXN (down 44%) because TSLA did phenomenally well.
I too am a fan of dividend investing, and my portfolio is more weighted towards them than you would expect from my age group.
I’m surprised you didn’t mention the tax inefficiency of dividend stocks, since you’re generating extra income during your working years — when you tend to be in a higher tax bracket.
It can eat into your returns
That said, I’m more than happy to take the slow road to wealth, rather than trying to catch a unicorn with huge tech gains.
It’s a personal and philosophic stance, rather than one rooted in finances.
I mention taxes, which is a drag, especially if you are in a high income tax bracket.
I’m much more biased towards growth stocks.
AGE AND RISK. I am 71. According to mortality tables, I have ten years left. A blink of an eye. I own Amazon, Apple, Netflix, PayPal, TQQQ and Tesla on margin.
If everything goes bad, I only have ten years to live with it. If at 30 I make a major mistake, I will live with it for 50 years. For 50 years, I won’t have that money invested, because I lost it at age 30. If I lose ten thousand at age 30, how much did I really lose at 8% for 50 years.
The secret is don’t lose the ten thousand dollars. How? Become educated. Read and read more and then you will understand diversification is not your friend, trading is foolish. Look at it this way. You are 30 and dating the person of your dreams, do you want to tell her/him you are a part owner of Apple or you own a mutual fund full of stocks you don’t care about. You’ll get it. You aren’t buying stocks, you are buying companies through stock ownership