For starters, growth companies are extraordinarily volatile and during difficult times they will test your mental fortitude. A company’s volatility is numerically defined as its beta, which measures the individual stock’s volatility in relation to the overall market. Growth companies typically have higher betas, which means they typically outperform the overall market in good years but underperform in bad years (hint: 2022). At times, the underperformance can be rough.
The other problem with investing in a growth company: They don’t share profits with their shareholders. Instead, growth companies reinvest profits aggressively back into the business in an effort to grow their products and services or enter new markets. When you think about a successful growth company, most of the technology businesses come to mind. Despite massive amounts of profits and cash on hand, most of these companies do not pay their shareholders a dividend because they are still expanding their footprint.
With dividend stocks, get ready for boredom. Think mature, steady businesses, who generate healthy profits but have reached the pinnacle of their growth. There’s always give and take: With lower risk comes lower reward. What do I mean by that? Well, when the broader market is up these businesses are generally also up but underperform the broader market; however, when the broader market is down, they typically are not down quite as much. Think steady.
So why invest in these types of companies if their market value is fairly constant? Well, not only do companies within this profile have inherently lower risk, but to varying degrees they pay you to own them. Unlike growth stocks, where you have to sell your ownership in order to actually make money, these businesses share company profits with stockholders in the form of a quarterly dividend. When determining the amount of a company’s typical dividend payment to shareholders, a quick Google search of its dividend history will provide this information for you.
Building a portfolio around dividend paying stocks is a great strategy for investors nearing retirement because the portfolio becomes a source of passive income without the requirement of selling the shares you own. The inherently lower risk of these stocks also makes sense for older investors as they look to preserve their capital as opposed to significantly growing it.
At the outset of this post, I proposed the question “are dividend stocks cool again?” I admit, as a regular joe being able to share in the profits of a dynamic business machine is pretty cool. Plus, it’s nice to own mature businesses that come with less risk. So why shouldn’t all investors move their entire portfolio to dividend stocks? Depending on your risk appetite, the answer is simple: As a young or middle-aged investor, your primary goal should be to grow your portfolio. This is why most long-term investors are ideally situated for a blended portfolio, which allocates specified percentages to both growth and dividend payers.
Are dividend stocks cool again? Absolutely. But the amount of dividend stocks that should make up your portfolio depends on your time horizon, risk profile, and overall goals for your investments.
Diversification cannot eliminate the risk of investment losses. Past performance won’t guarantee future results. An investment in stocks or mutual funds can result in a loss of principal.
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This material was written and prepared by Davis Wealth Management, LLC. © 2022 Davis Wealth Management, LLC.
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