When looking to invest in stock markets there are two main strategies, going for dividend yield or capital growth. There will be shares which offer a degree of both dividends and capital growth allowing you to create a portfolio around any investment strategy. There are obviously pros and cons with regards to dividend yield or capital growth which we will cover below.
Dividend yield
Shares offering high dividend yields, assuming they are safe, can help with cash flow and funds for reinvestment. In theory, when looking towards high dividend stocks there is likely to be less chance of capital growth when compared to the average share and especially those with no dividends but potential for capital growth. While some people see high dividend yield stocks as “boring” they can create significant long-term income streams and there is still the potential for limited capital growth.
It is also worth noting that stocks with relatively high dividend yields may not be as adversely affected by stock market falls when compared to capital growth stocks. This is because a lower share price equates to a higher the yield which is seen as defensive in times of trouble markets. So, anybody that suggests high yielding stocks are “boring” is probably somebody looking to take relatively high risks in pursuit of capital gains.
Capital growth
The vast majority of stocks with potential for capital growth have relatively low if any dividend yield and are probably most commonplace in the technology and biotechnology sectors. These tend to be relatively young companies with businesses which still have potential for enormous growth in the short, medium and longer term. They will pay no dividends because they are either loss-making at the moment or reinvest their profits back into the business. We only need to look at the US market since Donald Trump came to office to see how technology shares have increased dramatically. Loss-making companies such as Snapchat are a perfect example, worth circa $20 billion but having never made a profit.
When markets are riding high and investors are confident of the future then capital growth stocks will outperform their defensive high yielding counterparts. However, when markets turn down and investors turn negative you will likely see technology shares and biotechnology shares (and other shares offering capital gains as opposed to high yields) struggling. This is because they have no safety net such as a relatively high yield, with many also loss-making, and depend upon economic growth to prosper.
Balancing your investments
It is advisable to take professional financial advice if you are looking to invest a significant amount of your savings into the stock market. Work out your long-term strategy, what is your target and what is your timescale. There will be some investors who focus purely and simply on high yielding dividend stocks for safe long-term income streams while others are prepared to take significant risks on potential capital growth stocks. The vast majority of investors will be somewhere between these two extremes finding some middle ground which best suits their own financial situation.
If you are investing funds for your retirement you will likely switch from a more capital gains led strategy to one of dependable income streams as you approach retirement. This ensures that your funds are protected as much as possible from volatile market swings as you leave employment and begin to draw down on your investment funds.