What is the goal of your investment? The obvious answer is; to make more money. But that’s not incredibly helpful from a portfolio construction perspective. Broadly speaking, there are two overriding investment goals: growth and income.
Investing for growth
Investing for growth means making efforts to grow your principal. You want to choose a combination of investment options that will increase in value. If you’re buying stocks with a plan to sell them for a higher price at a later date, you’re investing for growth.
Typically, growth investments come with a high level of price volatility. After all, your principal doesn’t grow without changes in value. Common targets for growth investment include “small cap” stocks, or stocks whose outstanding shares have relatively low value. These companies are generally those with a great deal of room for expansion, which translates into higher stock prices in the future.
Many mutual funds and ETFs are set up for growth investment, as well. Popular choices for growth investors include funds that buy securities in “emerging markets,” or foreign countries with comparatively smaller economies. The most popular investment for individual investors, the total stock market fund, is also an excellent addition to a growth portfolio.
Growth investments tend to carry more risk than their income-oriented counterparts. Any security that experiences sufficient volatility, or frequent change in price, to create an opportunity for growth also carries the risk of losing value. Some of these, like total market funds, carry relatively little risk, but also stand to gain considerably less than their riskier counterparts in small cap or emerging markets if the market improves.
Income investing is the purchase of investment vehicles designed to generate a stream of income on a regular basis. Mostly, this income comes in the form of dividend-paying stocks and ETFs, although it can also include bonds and treasury notes. Rather than seeking to gain in value for resale, these investments are meant to be held for a long period of time, providing a predictable income all the while.
Income-oriented stocks tend to be those that already hold a high share price. These “large cap” stocks have little room for growth, but do have a stable income. They tend to use this income to offer dividends as a means of attracting investors. While they don’t approach the potential rate of growth that stocks with more upward mobility have, dividend stocks do offer a relatively safe return on investment. Companies like GE, AT&T and P&G, which have been around for a long time, are at a relatively small risk of losing a significant portion of their value, but pay a modest dividend for ownership regularly each quarter. The same is true for other popular income investments like treasury bonds and investor-grade corporate bonds.
Of course, not all income investments are quite as safe. One of the more popular investment vehicles, real estate investment trusts (REITs), face a high degree of risk. They tend to hold mortgages, which do have a default rate, or rental properties, which could face non-payment by tenants or vacancies. To make up for this greater risk, REITs typically offer a significantly higher rate of dividend payment. If large cap dividend stocks offer between 2-4% yield, REITs may offer between 5 and 10%.
Despite the availability of higher risk investments, income investments tend to encounter less risk to the principal. The risk they face is a relative one, that they may not grow relative to the rest of the market, leaving income investors out of market upswings. Also, there is no guaranteed income (outside of annuities, discussed in another article), and companies may change their dividend without consulting shareholders.
Which one is right for me?
Conventional wisdom sees these investments not as an either-or, but as a question of ratio. In general, young people who don’t need to depend on their investments as a source of income, and who have more time to recover from market downturns, should have a greater percentage of their investments in growth vehicles. As an investor ages, their portfolio should reflect a decreasing risk tolerance. By retirement, most of an investor’s portfolio should be in income vehicles, in order to replace the income that was previously earned through work.