Should I buy dividend shares or growth shares?

Should I buy dividend shares or growth shares?

If you’re new to buying shares, you need to consider what type of shares will best help you achieve your unique investing goals.

In this article, we will explore two common types of shares: dividend shares and growth shares. We’ll talk about their different characteristics and the types of investors and investment strategies they suit best. Hopefully, by the end of this article, you’ll be better equipped to decide which shares might be best for your portfolio.

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What is the fundamental difference between dividend and growth shares?

When you buy a dividend share, you expect to receive a steady income stream in the form of dividend payments. Companies usually make two dividend payments annually – an interim dividend and a final dividend. The amount of each dividend is disclosed in the company’s mid- and full-year results announcements.

Growth shares, on the other hand, are unlikely to pay their shareholders any dividends at all. Investors buy growth shares hoping to profit from increasing share prices over time. Some growth shares can experience considerable gains in a surprisingly short timeframe but be careful, they do carry additional risk.

What types of companies are ASX growth shares?

As we just mentioned, not all companies pay dividends. This is because companies choose what to do with the money they earn. They can either reinvest their earnings into their business or pass them on to shareholders as a cash dividend.

Younger companies often reinvest most (or all) of their earnings into their business. They will often spend earnings on marketing, advertising, and product development to increase their future earnings potential. These types of companies are growth shares.

With growth shares, you are buying shares with the expectation that those companies will become profitable in the future, and their share prices will increase over time. But the future is impossible to predict, and not all young companies will reach their full potential. In fact, many will probably fail.

This is why investing in ASX growth shares is much riskier than investing in dividend shares – but it can occasionally make some lucky investors extremely rich!

What types of companies are ASX dividend shares?

Established companies that have already achieved a large and stable market share are likely to distribute more of their earnings to shareholders as dividends. This is because they have already achieved significant market penetration, so they no longer need to reinvest a large proportion of their earnings into growing the business. You might have heard these companies referred to as ‘mature’ companies.

Mature companies that can pay reliable dividends are called dividend shares. Many are considered ‘blue-chip’ companies and are usually among the largest ones listed on the ASX.

Some good examples are utilities companies, large established banks and financial services providers, airports, and toll road operators.

However, the trade-off when buying ASX dividend shares is that they are unlikely to deliver the same capital gains as growth shares. This is because most mature companies have less room for growth. They’ve just about reached their full earnings potential, so we expect to see lower fluctuations in their share prices. 

Which investment strategies align best with dividend and growth shares?

Different investment strategies provide various benefits.

For example, some investors prefer an investment strategy that protects their existing wealth but also provides a modest income stream to support their way of life. Dividend shares suit this strategy best.

Other investors might not need additional income right now, and would instead try to maximise their wealth over the longer term. Careful selection of growth shares is better for this strategy. 

Who invests in which ASX shares?

Although every investor is unique, we can still make some generalisations about which investment strategies suit certain types of investors.

For example, retirees are more likely to pursue investment strategies involving dividend shares. Retirees are typically more concerned about preserving the value of their wealth while also getting a little extra income to support them through retirement. Dividend shares provide a pretty good way of achieving both those goals.

Younger investors with stable employment, on the other hand, may be more inclined to invest in growth shares. These investors generally have a long investment time horizon and may have more disposable income than retirees (so they probably don’t have as great a need to supplement their current income with dividends).

There are also different tax implication to consider. Dividends form part of your taxable income each year but they can also provide tax benefits in the form of franking credits. Franking credits can be used to reduce the amount of tax you have to pay each year and may even help retirees secure a tax refund.

However, younger investors might get more tax efficiency out of growth investing. If you buy and hold shares for more than 12 months, the Australian Tax Office (ATO) allows you to claim a 50% discount on the taxable capital gain.  

At the end of the day, it’s important to remember that each investor’s strategy should be determined by their own personal circumstances and financial objectives, so there are no hard and fast rules. Some young investors may prefer dividend shares, and some retirees may seek out growth shares. It all depends on your individual investment goals. 

Do growth shares ever become dividend shares?

Yes, they do! Most successful companies follow a similar life cycle. After their launch, companies will often progress through a relatively rapid growth phase before eventually plateauing into maturity. If a growth company reaches maturity – and is profitable enough – it can start returning more of its earnings to shareholders as dividends.

This means if you buy the right growth share and hold it for long enough, it could one day become a bona fide dividend share.

In this situation, an investor’s portfolio might mature with them into retirement. As the investor’s needs change with age, from seeking capital appreciation to preferring a stable income stream, their portfolio’s characteristics will also change – without them having to make any trades. This is an ideal scenario for many investors.

So, are dividend shares or growth shares right for you?

As we’ve discussed, each investor needs to tailor an investment strategy that best suits their own circumstances and investment objectives. So, when deciding whether dividend shares or growth shares are right for your portfolio, the first step is determining what you’d like your portfolio to achieve. 

Do you want to grow your wealth over the long term, or would you rather try and preserve your wealth while generating some extra income?

Remember, you can always pursue a hybrid strategy and buy a mix of both growth and dividend shares – it’s all up to you!

Last updated June 2022. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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