Today, there are many funds that you can choose to invest your money in, and there are even more choices when it comes to the kind of investment you should be making. Some funds are considered growth funds, and others are considered dividend funds. When looking into which type would be best for you, it is important to know the difference between the two.
Keep reading to discover the advantages and disadvantages of each, how they differ and which would best suit your interests.
What is the dividend fund option?
A dividend is a kind of income you get from investing in stocks. It is the amount of money given to shareholders out of its profits.
Dividend funds regularly pay out a percentage of the fund’s total value to shareholders. This is known as a dividend and can be cash or reinvested into more fund shares. The number of dividends paid per year may differ depending on the fund.
For example, some funds payout four quarterly dividends per year while others may only pay twice.
An example of a popular dividend fund is the Vanguard High Dividend Yield Index Admiral Shares (VHYAX).
Advantages
Some investors like these funds because they will always receive a steady income. This is important to many investors, especially those who are retired or close to retirement. These investors would prefer to buy shares in a stable fund that pays regular dividends because they do not want to worry about their principal decreasing over time due to market volatility.
While dividends fluctuate with market conditions, they are generally more stable than capital gains which go up and down due to changes in stock prices.
Dividends tend to be taxed less than capital gains since most people will fall into lower tax brackets if they receive dividend income rather than capital gains income.
Also, dividend investing is considered less risky than growth investing. Because you’ve already gotten paid, you don’t have the same worries as someone who hasn’t yet gotten his return. And, since you get paid every time the company makes a profit, it’s easier to stick to your investments even when the stock market is down or stagnant for some time.
Disadvantages
Keep in mind that dividends are usually paid out of the company’s net profits and have an element of risk that growth funds do not because they do not necessarily match the stock market’s performance. So if a company has a bad year, it may cut its dividend payout or eliminate it.
In addition, dividend funds may also have higher expenses than growth funds because the management fees are higher.
Another disadvantage is that many of the best long-term investments do not pay dividends or pay no dividends until they mature. For example, Apple Inc did not start paying out dividends until 2012, and Google has never paid a dividend.
Large, established companies also pay lower percentage yields than small caps. So unless you invest in a specialized fund or sector, the yield may be quite low. Other than that, dividend-paying funds offer more stability and less risk than growth funds.
What is a growth fund option?
Growth funds, also known as capital appreciation funds, are mutual funds that aim to generate growth by investing in stocks that may increase in value.
A fund’s performance is usually measured against a relevant benchmark index such as the S&P 500 Index. Many growth funds invest only in stocks of large companies that pay little or no dividends.
However, some growth funds invest primarily in small-cap stocks, and others invest in large-cap and small-cap companies. To generate higher returns from their investments, many growth funds take greater risks than other types of mutual funds, such as income or bond funds.
Some growth stock mutual funds focus on one industry, such as biotechnology, while others invest more broadly across many industries.
The largest growth fund in America is the Growth Fund of America (AGTHX) from American Funds with stocks from Meta (or Facebook) counting for 5.8% of its assets.
Advantages
Growth funds have several advantages. First, they are not affected by tax law changes in how dividend fund returns can be. If a growth fund has a capital gain and you sell your shares, you must pay taxes on those gains at the prevailing rate. It’s possible to avoid the taxes altogether if you hold on to your investment or reinvest it back into the same fund or other growth funds.
Another advantage is that growth funds tend to make money overall, even in down markets. This is because growth funds always seem to be able to find something that will increase in value over time. Growth funds compound faster than dividend-paying stocks and grow larger over time.
For example, in a down market, there might be less demand for stocks from foreign companies with high price-to-earnings ratios. But if those companies are well run, their stocks may still go up due to increased demand from overseas investors.
Growth funds can also be used as retirement savings vehicles because of their ability to avoid some of the pitfalls of investing in stock mutual funds. Instead, many investors reinvest their dividends into additional shares of the growth fund, which compounds their returns even faster and results in a larger end value at retirement age.
Disadvantages
Though growth funds can provide great returns, there is a necessary disclaimer that growth funds are riskier than dividend funds because you aren’t guaranteed anything at all. However, if the company isn’t doing well and your shares drop low enough, you can get rid of them without making any money at all––or worse––losing money on them.
Investing in high-risk assets means that there’s a possibility of losing most or all of your investment during stock market corrections or crashes. For example, this can happen if you buy shares at a high price and then sell them when they crash because of an economic recession or other causes.
There are also limited diversification opportunities. Diversification is one of the best ways to minimize risk in investing. But if you put all your money into growth mutual funds, you won’t be able to diversify your portfolio effectively.
Growth funds are also not suitable for all kinds of investors. For example, if you’re nearing retirement age and need a stable portfolio that will provide you with income in your later years, having all of your money invested in growth funds may not be the right choice. There’s also the risk that growth fund prices could fall during your investment period.
How are dividends and growth funds similar?
They both have the same end goal: returns
Both dividend funds and growth funds want to make money from the stock market without actively managing their investments. However, only the way in which they go about this is is different to meet the goals.
They invest in similar instruments
Both kinds of funds invest in stocks, bonds, and other types of securities such as real estate.
Both types of funds tend to hold stocks that pay dividends, which allow a company to return some of its profits to shareholders without reducing its growth rate.
They have similar management heads
Both dividend and growth funds are run by professionals and fund managers who study the companies carefully to ensure the investments are solid.
How are dividends and growth funds different?
The approach to achieve returns
Dividends and growth funds have some key differences, but the most significant difference is the focus of how they achieve the returns they both aim for.
Dividend funds focus on paying dividends to their investors, while growth funds focus on increasing the value of their investments over time. Dividend investors invest in companies that pay stable dividends, and growth funds invest in companies expected to have rapid growth.
As such, growth funds tend to outperform dividend funds. The total returns from both can vary.
The focus of financial instruments chosen
The main difference between them is that dividend funds tend to focus more on large-company stocks since they tend to pay dividends more often than smaller companies.
On the other hand, growth funds usually invest in small and/or medium-sized companies because these companies often have more room for growth than larger companies do.
Fee structures differ
Growth funds tend to have higher fees than dividend funds. If you look at the advertised charges, they can be as much as one percentage point a year higher. That’s worth keeping in mind when comparing fund performance.
Time horizons are different
Dividends are defined by shorter investment horizons as cash is received on a periodic, steady basis.
Growth funds are much more long-term, and investors only get the payout at the end of a defined period, usually at the time of redemption or sale.
Tax efficiency
Dividend returns tend to be income tax-free at the hands of the investor, but this is not the case with growth funds.
Growth fund investors are often required to pay capital gains tax at the time of redemption. This can differ if opting for longer schemes (think 15 years or more), but all in all, dividend funds are more tax-friendly.
Liquidity
While growth funds can earn great returns, they are not as liquid as dividend funds. As a result, the payout ratios for both are vastly different.
Dividend funds can be redeemed at the end of each day and provide steady payouts, while growth funds can only be redeemed at the end of the defined period.
Dividend vs. Growth Fund: What’s right for you
This may be a bit of a surprise to some investors, but as it turns out, dividend-paying stocks and growth stocks can be very similar in that both offer a way for an investor to get their money back, potentially with interest (the dividend).
Both also have advantages and disadvantages depending on one’s risk preference, patience, and personal situation. Sorting through the maze of choices can be confusing, but here are some pointers that might be best for you.
When you should consider dividend investing
If you’re looking for income, then dividend funds are the best choice for you. You can expect to receive regular payments from dividend funds from companies that have paid out dividends, which is a great way to get some income flowing into your account without having to take any money out of your investments.
These kinds of investments are perfect if you’re looking for a steady stream of income each month or quarter and also hope that the share price will increase over time. This is especially true if you also plan for dividend reinvestment since that will boost your overall returns.
For example, it’s a great option for retirees when they’re looking for ways to manage their personal finance.
When you should consider growth options
If you’re young and still working, then growth funds are almost always a better choice than dividend-paying stocks because you’re not benefiting from the immediate cash flow but rather the company’s long-term value.
Growth funds appreciate faster than dividend stocks because they are typically more volatile and have high risk/high reward investments.
For many people, it’s simply easier to let a growth fund compound over time and provide long-term capital gains rather than having to constantly monitor your dividend payouts and track the term growth and performance of the company quarter by quarter.
When you should consider both
You may even want to consider investing in a mix of both through the mixed allocation of your investment resources. Benefitting from both dividend payments and dividend growth gives short-term stability while also benefiting from the long-term valuation and strong performance of stocks.
Oftentimes, people use both growth and dividend funds together to diversify their portfolios. In this case, a person might put the majority of their money into a dividend fund and then use that money to invest in a growth fund as well.
Investors who seek diversified portfolios might invest in a mix of equity funds, high yield debt funds, ETFs, and more.
But in a nutshell, if you want a simple rule for choosing between dividend and growth funds: if you want income (dividends) and you’re willing to accept slower growth, then choose a dividend fund. If you want growth and don’t mind its risk, choose a growth fund.
FAQs
Which is better: dividend or growth mutual fund?
Growth funds have the advantage of compounding returns; however, they are more volatile and less liquid. Dividend returns provide steady returns that might be lesser in value but are liquid. Which is better depends on your investment strategy.
Do growth funds pay dividends?
Growth fund investors do not receive dividends as they are reinvested in the fund itself. Growth funds follow a compounding policy in this way.
Are dividend funds a good investment?
Dividend funds provide healthy and stable returns to investors, even when the market is challenged or unstable itself. They also protect against inflation and tax benefits.