There’s three ways to make money from stocks and shares:
- Invest for growth
- Invest for income
- And invest for bargains
The approach you choose depends on why you are investing and your investment timeline. I’ll explain more in a minute, but first let’s take a more detailed look at the three approaches:
Investing for growth
When you invest for growth, you buy shares in innovative businesses you believe will grow very big, very quickly. Profits are reinvested into the business to drive growth, so there won’t be any dividend payments. Instead the value of your shares will grow as the business grows (unless things go wrong of course).
A good example is Amazon. Early investors wouldn’t have seen a penny in returns for many years, but by 2019 a $500 investment in Amazon shares back in 1997, would have been worth $568,620!
It’s important to note that Amazon bled cash in the early years and its stock price has gone up and down like a wild roller coaster ride, so many early investors would have been tempted to sell their shares along the way. Hindsight is a wonderful thing 🙂
Investing for income
If you prefer a little more reliability in your life, you can choose to invest in solid ‘blue chip’ companies that have stood the test of time and pay a regular dividend to their shareholders.
These sorts of businesses have already gone through their wild growth phase and are now at that comfortable mature stage where (in human terms) they prefer a night in with Netflix and a takeaway.
BP is one example. The energy company has been around for decades and continues to pay a regular dividend to shareholders. This provides a nice little income stream for shareholders.
One word of caution though; a good dividend paying company may struggle to maintain its dividend payments in the future, especially given the fast changing nature of the world today. BP is an energy company with big interests in fossil fuels. If it fails to adapt quickly enough to changing market needs it could have its own ‘Kodak Moment’. Goodbye share value and goodbye dividend income.
It’s a bit like life really. One minute you’re comfortably at the top of your game and then before you know, some young hotshot has come along and stolen your thunder 😮.
Investing for bargains
Investors can be a fickle lot. Chasing after returns in the hope of beating the market, they’ll follow the crowd to invest in the latest trends.
In recent years, both Zoom and Peloton skyrocketed in value, as investors piled in on the working-from-home trend caused by the global pandemic. Then when things reopened after the lockdowns, interest in those stocks waned.
Businesses can simply go out of fashion with investors. Less demand means share prices decline, even if they still hold their intrinsic value. Some businesses go out of fashion for years (just like a pair of brown corduroys) and this provides the opportunity to buy valuable companies at bargain-basement prices.
Investors who go against the flow and look for unloved, bargain shares are known as ‘Contrarians’ and perhaps the best known contrarian bargain hunter is Warren Buffett, the American investment legend.
So which approach do you choose?
The honest answer is, I don’t know. It all depends on your attitude to risk and your investing timeline.
Growth stocks are obviously appealing, but how do you know what’s going to be the next Amazon? You’d have to invest your money in a whole range of potential growth stocks to stand a chance of finding ‘the one’ that makes the big time. And would you be able to stomach the ride over all those years of ups and downs?
Income stocks provide passive income and are probably best for people who are planning to retire. But the best years of growth have been and gone, so you need a lot of these stocks to cover living expenses. And what if your cash cow takes a turn for the worst?
Value stocks sound great, but finding them is tricky and you’ll have to put in the time to thoroughly research the businesses you’re looking at to ensure you’re not buying a dud.
Stock picking is hard. It’s hard because we have to make decisions about what we do with a scarce resource (our money), often with insufficient information. We also have to deal with our human emotions which lead us to make illogical choices, and we’ve got to live with those decisions.
My preferred alternative is to just invest in a low cost index fund. It just makes life so much simpler!
Thanks for reading 🙂