One of the most important factors when drawing up an investment strategy is deciding whether you want your money to grow or to provide a regular income.
These two criteria are not mutually exclusive – company shares which pay regular dividends can also increase in value. But the growth versus income question can provide a useful way working out what investments and/or financial products are the most suitable for your circumstances and needs.
Investing for growth
If the aim of your investment is solely to increase the value of your portfolio, this may lead you to put money into “growth” shares and funds. Typically, this means investing in companies which are expected to increase in value at a higher-than-average rate – they could be relatively new businesses, or may operate in markets or sectors where long-term growth prospects are thought to be greater.
Such investments usually come with a higher level of risk and volatility, so there is also potentially a greater chance they will decline in value over certain periods. But over longer timeframes, the expectation is that overall returns will be higher than could have been achieved through other investments.
Investing for income
If you want your investments to generate a regular income, a different approach is needed. Larger, longer-established businesses are more likely to generate enough profit to pay regular dividends to shareholders, and firms such as these are more commonly the focus of income investors.
By holding shares in blue-chip firms – the nickname for the biggest companies in an index – investors will still be able to benefit from some equity growth but, over longer periods, this growth rate is likely to be lower than among “growth” firms described above.
As well as putting money into equities, there are other ways of generating income: holding cash has been a traditional option but at the moment global interest rates are at or near all-time lows.
Corporate bonds are viewed as less risky than shares but can produce reliable income streams. Annuities are a way of turning pension savings into a guaranteed income for life, but here rates are also low at present.
Changing your strategy
Your age and the stage of life you are at play important roles in deciding between growth and income-focused investment strategies. Going exclusively for growth is often more suitable for younger individuals who are investing for the very long term, for example in a pension.
As you approach retirement, it may make sense to gradually shift your portfolio from higher-risk growth investments to lower-risk income holdings. This helps ensure your portfolio does not suffer any sharp falls in value immediately prior to retirement.
Equally, if you are investing for a limited period – less than 10 years, for example – it could be more suitable to stick to lower-risk income investments, as your holdings may not have enough time to ride out any falls in value.
A combined approach
With life expectancy rising, however, it may no longer be appropriate to switch entirely to a low-risk, income-generating portfolio on retirement. With people today expected to live for around two decades after they start taking their pensions, it now makes more sense to keep at least some money invested for growth even after giving up work.