I think there are two big reasons why young ASX investors should go for growth shares.
There’s nothing wrong with going for businesses paying rising income streams, but going for income could be a negative if that business isn’t growing.
I do believe that holding ‘income’ shares like Commonwealth Bank of Australia (ASX: CBA), Vanguard Australian Share ETF (ASX: VAS) and Argo Investments Limited (ASX: ARG) will provide better total returns than property, cash or bonds over the next decade, but growth could be the better choice because of these two reasons:
Compounding is the most powerful financial force. It’s great if it’s on your side and terrible if it’s working against you.
This isn’t an anti dividend re-investing point, I think re-investing your dividends is one of the best ways to growth your wealth.
My point is that businesses that can earn returns of more than 10% on retained profits are better off re-investing that money for growth rather than paying it as a dividend. Some businesses can earn returns of more than 20% on retained money. This compounding of retained money is what drives great long-term returns.
Australia’s biggest businesses have essentially reached market saturation, there is little reason for them to retain money – there isn’t much to invest in. For good long-term total returns, it’s better to focus on businesses that have plenty of investment options.
Another reason to think that growth returns are better than income is tax. If most of our returns are dividend based then we’re likely paying tax throughout our investment journey unless you have a 0% tax rate. Labor’s plan to crimp franking credits makes this argument even stronger.
Taxes are useful, they are the subscription fees that pay for the building blocks of a good society. But you don’t want to set yourself up paying more tax than necessary.
For that matter, frequently trading is also a bad thing because of all the tax events you’re creating – which is a paperwork nightmare too! Not to mention the brokerage costs.
The best way to beat the market over the long-term in my opinion is to invest in growing businesses that have runways where they can re-invest for many years. Commonwealth Bank is not the best example of this in my opinion.
Motley Fool contributor Tristan Harrison owns shares of Altium, Bapcor, and Magellan Flagship Fund Ltd. The Motley Fool Australia owns shares of and has recommended Bapcor. The Motley Fool Australia owns shares of Altium. The Motley Fool Australia has recommended REA Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.