Retail investors are confronted with a multitude of investment options ranging from savings accounts and CDs to stocks and bonds. When venturing out of the safest (and lowest yielding) FDIC-protected options into stocks and bonds, it’s difficult to choose between various asset classes. There are two key categories to think about first, and then refine further later.
Income Investments for Yield
This is often the more conservative approach, trading the opportunity for an increase in your initial principal for a routine payout. This might be in the form of coupon payments for bonds or dividends for stocks and ETFs. Now, there are many stocks that are relatively volatily AND provide a steady dividend payout, but often times, the volatility is muted and a reasonable floor exists under a certain level since it’s unlikely that investors would allow a high yielding stock to dip too low, or else it appears too attractive to buyers given its yield. At the furthest spectrum of conservative investing of course would be savings accounts, money markets and CDs, but for the most part it’s difficult to even exceed 1.5% in any of these asset classes, so over the past year, the “risk trade” has been on with investors piling into stocks.
Income investments and dividend stocks in particular have a penchant for protecting investors from downside moves given the steady payout. And much of the 8-10% total returns over long periods of time in the blue-chip indices came from dividends. Depending on the data set, many economists put that contribution at close to 50% of total return. So, reinvested dividends can go a long way, especially in a flat market like we just saw during the prior “lost decade” of stock market returns.
Growth Stocks for Capital Appreciation
Generally, stocks in the growth phase of their life-cycle don’t even pay a dividend. Investors are banking on the potential for a dividend perhaps years or decades down the road, but they aren’t banking on one in the near future. They’re banking on continued earnings growth which will drive the share price up as the price-to-earnings ratio justifies a higher share price. Typical examples of hot growth stocks with a strong share price trajectory over the past few years would include Apple and Priceline.com. Rather than sending cash out the door to shareholders, these growth companies reinvest in new areas, growth and acquisitions.
Which is Better?
It depends. That’s probably not the answer you’re looking for, but it depends on which time-frame you look at, which stocks are included in your analysis and whether or not you consider volatility (risk) in your assessment. For more conservative investors, especially if the time horizon until funds are needed is short, the income investment approach is usually recommended. For younger investors that might be saving for retirement of their children’s college savings plan 15 years down the road, it’s often appropriate to allocate a substantial portion of a portfolio to more aggressive capital appreciation assets.
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