Many stock-market pundits and financial planners regularly promote the concept of investing in dividend-paying stocks as a way to generate income and to grow one’s nest egg.
However, I’ve found over the past 25 years that a better approach is to invest in a diversified stock portfolio of growth companies.
Although stocks of growth companies tend to be much more volatile than stocks of dividend-paying companies, and to decline more than dividend-paying stocks during economic downturns, they tend to appreciate much more than stocks of dividend-paying companies during economic expansions.
As an example, the Chinese version of Google, Baidu (BIDU), appreciated 883 percent from the time that the major U.S. stock-market indices bottomed on March 9, 2009, to yesterday’s close, while home-movie provider Netflix (NFLX) rose 495 percent and online provider of airline tickets and travel services Priceline.com (PCLN) returned 586 percent during that period.
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Someone that invested equal amounts of a $100,000 portfolio into BIDU, NFLX, and PCLN on March 9, 2009, would have experienced a more than sixfold increase in the value of that portfolio of stocks as of April 26, 2011.
In contrast, someone that invested equal amounts of a $100,000 portfolio into dividend-paying favorites Altria (MO), Johnson & Johnson (JNJ) and Coca-Cola (KO) would have captured only a 73 return during that same period.
Although many people are uncomfortable investing in the volatile stocks of growth companies, the examples above clearly illustrate that those stocks can often generate much higher returns than stocks of dividend-paying companies.
Yet, I would advise anyone that’s considering investing in such stocks to do so only if he or she invests in a diversified portfolio of such stocks, meaning in at least 15 of those stocks. That’s because stocks of growth companies tend to fall sharply when the revenue and earnings growth of those companies slows or when those companies’ quarterly earnings fail to meet the expectations of Wall Street analysts.
Hence, if an investor were to invest in only a few stocks of growth companies and the quarterly earnings of those companies all of a sudden slowed considerably, the investor would likely realize a substantial decrease in the value of his or her holdings.
Some good examples of diversified portfolios of growth stocks are the Lord Abbett Developing Growth Fund (LADCX), T. Rowe Price New Horizons Fund (PRNHX), and Vanguard Small-Cap Growth Fund (VISGX).
In regard to the income that’s offered by investing in dividend-paying stocks, an investor can generate just as much, if not more, income by investing in stocks of growth companies or in mutual funds that focus on investments in stocks of growth companies and then selling a portion of his or her holdings in those securities during any given period.
About the Author: David Frazier
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