Ask Stacy: Which Is Better — Dividend or Growth Stocks?

Ask Stacy: Which Is Better — Dividend or Growth Stocks? Photo (cc) by TerryJohnston

Hopefully you use stocks, or stock mutual funds, as part of your overall investment mix. If so, you’ll find this week’s question interesting.

Hi Stacy:

I have some stocks that I bought for gains, others that I bought because they have a high dividend. The growth stocks tend to go up, but don’t pay anything. The dividend stocks pay dividends, but don’t seem to go up much.

That leads me to wonder: Which is better? Will I make more in the long term by buying stocks that will increase or those that pay big dividends?

Thanks, and please do keep up the great work!
– David

Congratulations on spreading your wings and looking outside traditional savings accounts in order to earn more. And further kudos for doing the research necessary to select appropriate investments.

I also own growth stocks, as well as dividend stocks. The short answer as to which is better is neither: They’re both good. But let’s start this discussion with a quick look at stocks in general and dividend stocks in particular.

Stocks vs. bonds: owner vs. loaner

While it may appear that there are hundreds of ways to invest, when you boil it down, there are only two: You can either be an owner or a loaner.

If you have money in the bank, you’re a loaner. You’re loaning money to the bank in exchange for some interest, as well as a guarantee that at some point in the future you’ll be reunited with your money.

If you invest in stocks, you’re an owner. Your stock investment represents ownership in a business. As with owning any business, there are no guarantees. Your reward comes when your share of the company becomes more valuable and you sell it to someone else. What makes it more valuable? Simple. The company is making more money.

Since ownership investments have more risk, they offer greater rewards. This makes sense: After all, if the stock market didn’t return more over time than risk-free investments like Treasury bills or an insured bank account, nobody would put money there. Over long periods of time, ownership investments like stocks typically earn about double the return of “loanership” investments like bank accounts.

That being said, because of their longer term, more volatile and riskier nature, it’s dumb to put all your eggs into ownership baskets. Everyone needs both: safe, but boring, loaner stuff and more exciting, but riskier, owner stuff. How much to put in each depends on lots of things, from your age to your risk tolerance. For a quick idea, see A Simple Way to Invest Your Retirement Savings.

Dividend vs. growth stocks

Hopefully, any company you invest in will make money. But what will it do with the money it makes? In the beginning stages of a company’s lifespan, it will do exactly what you did with the first extra money you made: Save it for a rainy day. When it’s built an adequate emergency fund, the company will do what you’d do with extra income: Use it to make more. For example, a company might buy a competitor. It might build a new, more efficient factory, open locations overseas or start a new product line.

Companies that are focused on expansion are, logically enough, labeled growth companies. And as their business and profits expand, so (hopefully) does their stock price. Pretty exciting stuff if you’re a shareholder.

But what about companies that don’t need all the money they’re making to expand? Maybe they’ve been around so long, they’ve already got a location on every corner. Or maybe they’re making so much money, they simply can’t spend it all on expansion. What then? Well, they might start paying part of the profits to their shareholders. That money is called a dividend.

Traditionally, stocks that pay big dividends are more stable and less exciting. The company is mature. Their profits aren’t expanding as rapidly and thus their stock price isn’t either. Their sole source of excitement is the quarterly dividend check you get in the mail.

Which is better?

In an ideal world, you’ll find stocks that both pay dividends and go up. Example? Apple.

Got more money questions? Browse lots more Ask Stacy answers here.

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