Should you invest ASX dividend shares, or growth shares?

Dividend shares or growth shares, or both? Deciding how you invest your hard-earned money can often start with this simple question. Here’s a closer look at both options.

| More on:
Retirement portfolio management

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Dividend shares or growth shares? Or both? Deciding how you invest your hard-earned money can often start with this simple question.

There are a number of factors to consider, including whether you need an income from your shares, and what your investing time horizon is. Many people may be happy to dabble in both dividend and growth shares by investing half of their portfolio in high yielding shares and the other half in growth shares with no dividends. But is that the best solution, or should your portfolio be skewed one way or the other?

To help you decide how to structure your portfolio, we take a closer look at the pros and cons of dividend shares and growth shares below.

Dividend shares versus growth shares

If you need to live off your portfolio (say, as a retiree), or use it to supplement your current income, then you’ll want to invest at least the majority of your portfolio into high-yield dividend shares.

Shares such as Rural Funds Group (ASX: RFF), Macquarie Group Ltd (ASX: MQG) and Telstra Corporation Ltd (ASX: TLS) are all great candidates for a dividend-focused portfolio, in my view.

However, if you don’t require any additional income, I think there is an argument to be made for growth shares. Shares such as Altium Limited (ASX: ALU), Afterpay Ltd (ASX: APT) and Nearmap Ltd (ASX: NEA) all fit this bill.

The best way for me to demonstrate why is via a little bit of maths. If you’re not so keen on formulas, you can skip right to the results!

The math

Let’s assume a starting investment of $10,000, with an average return of 10% each year and a marginal tax rate of 32.5% (which is the rate for a taxable income of $37,001–90,000).

Using these figures, we will work out the total return difference between a dividend and growth-focused investor over 10 years.

Dividend investor

To keep things simple, we will assume the total return from the dividend shares to come from the dividend itself; that is, we assume the 10% return to come in the form of an annual dividend.

  • Formula: Investment[1 + r(1 – T)]^10 = 10,000[1 + 0.1(1-0.325)]^10
  • Post-tax return: $19,217

Using the appropriate formula we get an end result of $19,217. Now that’s nearly double your initial investment, and assumes the dividend each year is reinvested at the same 10% rate.

However, what hurts this return is paying tax each year on the return prior to letting it compound. So let’s look at the growth scenario for comparison.

Growth investor

Again, keeping things simple, we will assume the company pays no dividend, and all returns come in the form of capital gains. Additionally, for a share holding period of greater than 12 months the owner only needs to pay capital gains tax on half of the gain. This makes the formula a little more tricky but if you’re not interested in the maths, remember just look at the results.

  • Formula: Investment(1 + r)^10
  • Pre-tax return: $25,937

Now, since we only pay tax on half of the capital gains:

  • Formula: $25,937 – [0.5 x (25,937 – 10,000) x 0.325]
  • Post-tax return: $23,347

The growth investor walks away with a post-tax return of $23,347 on their initial investment, which is nearly 22% more than the dividend investor.

Foolish takeaway

As you can see, there is a decent difference between the two approaches over the 10-year time horizon, and this gap only increases when you increase the holding period. This is mostly thanks to the pre-tax compounding effect of the growth shares. Essentially, with growth shares you only need to pay tax after you have sold them, therefore the asset’s compounded rate of return is higher.

However, because many companies pay a dividend and retain a significant chunk of earnings for reinvestment, you can hope for capital and dividend returns.

That being said, if you have a long time horizon and limited need for the dividend income, I believe it can pay to skew your portfolio to growth shares.

Michael Tonon owns shares of Nearmap Ltd. and RURALFUNDS STAPLED. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of AFTERPAY T FPO. The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited, Nearmap Ltd., RURALFUNDS STAPLED, and Telstra Limited. The Motley Fool Australia owns shares of Altium. 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.

More on ⏸️ Dividend Shares

falling healthcare asx share price Mesoblast capital raising
⏸️ Dividend Shares

Sonic Healthcare (ASX:SHL) dividend rises 7%, share price falls after FY21 results

Triple digit profit growth and a solid dividend was not enough to impress investors on Monday.

Read more »

A smiling woman with a handful of $100 notes, indicating strong dividend payments
⏸️ Dividend Shares

The Adairs (ASX:ADH) dividend more than doubled in FY21

A record financial result will see a generous dividend paid out to Adairs shareholders.

Read more »

A businessman on a road raises his arms as dollar notes rain down on him representing the dividends that NAB will pay over the next few financial years to shareholders
⏸️ Dividend Shares

The Newcrest (ASX:NCM) dividend boosted 129%

Newcrest marks its sixth successive year of increasing dividend payments to shareholders

Read more »

Happy couple laughing while shopping in supermarket
52-Week Highs

August has been a great month so far for the Woolworths (ASX:WOW) share price

We take a look at how shares in the supermarket giant have been performing ahead of the company's full-year results

Read more »

wine glass full of coins
⏸️ Dividend Shares

The Treasury Wines (ASX:TWE) dividend bumped up by 60%

Here's how Treasury Wines dividends for FY21 have stacked up.

Read more »

Young boy cries and covers eyes with torn money on table
⏸️ Dividend Shares

The Origin (ASX:ORG) dividend has dropped 20%

What's happened to Origin's dividends?

Read more »

two people hold a sheet above their head while making a bed in a room featuring homewares.
Retail Shares

How did the Adairs (ASX:ADH) share price respond last earnings season?

The homewares retailer will be looking for another year like last year when it releases its FY21 earnings tomorrow.

Read more »

Two men excited to win online bet
Share Market News

Why the Tabcorp (ASX:TAH) dividend was boosted by 32%

The strong performance of Tabcorp's business will see a combined FY21 dividend of 14.5 cents.

Read more »