September 20, 2019
When the Chrysler Building opened its stylish art deco doors in 1930, it became the world’s tallest structure. The now-iconic New York City building reigned king of skyscrapers worldwide, but held its title only 11 months, when it was outreached by the magnificence of the Empire State Building, whose developers achieved both growth in tenant space and income for its owners. But before its first iron girder was placed, did its investors understand their objective—growth or income?
Investors put their money into “vehicles” (for example stocks, bonds or REITs) to meet financial objectives such as retirement, saving for college, or buying a home. Certainly, every investor wants to make money, but what investment vehicles will make their money grow? That depends on their objectives, how long an investor has to invest, and their appetite for risk.
Consider two scenarios, one is an investor with a retirement time horizon of 15 years, while another investor is nearing retirement in just a few years. Both want the best possible retirement portfolio. The difference is that the investor with a longer time horizon of 15 years may invest for higher returns, and can take on more risk, since they have more time to make up for possible losses. The investor nearing retirement has investment preservation in mind and a preference for less risk.
Every investment involves some risk, and investment values may increase or decrease in response to economic, financial and political events. Risk and return tend to move in the same direction, higher potential rewards come with more risk, and less risk is associated with lower returns.
These investment scenarios identify two main investment vehicles—growth investing and income investing. What’s the difference?
Growth investing emphasizes capital appreciation, the growth of money invested. These investments, such as company stock, rest on the potential for future growth. Some growth stocks are companies with an innovative product or service to offer, lots of room to grow, and grow at a faster rate than many other companies. To achieve this growth, these companies put much of their revenue back into their business, as they seek higher revenues.
Growth investments resemble company ownership in some ways, as the investor participates in the earnings (and losses) of the company. These earnings and potential for future earnings growth are the primary factors that drive the appreciation of a growth investment.
Large and small companies can be growth investments. A large company may grow earnings through new product lines and a cost-efficient business model. On the other hand, a small company may have better overall growth potential as they bring innovative, new products to the market where none existed before. Smaller companies tend to be riskier investments than larger ones, as they have a less predictable future. Companies all along the size spectrum from small to large can provide ample capital appreciation opportunities.
Growth investing offers an investor an opportunity to realize substantial returns on investment. Growth investments are usually suitable for investors who seek maximum capital appreciation, have a relatively long time horizon, and hearty tolerance for risk.
Income investors seek a maximum amount of income from their holdings. These investments are designed to generate current income and preserve capital. Income generated from an income investment may come from a source such as a stock dividend, rental income, or bond interest payment. For instance, companies raise funds for their business by issuing bonds, loans that pay investors interest in exchange for the loan. Governments issue bonds, too. In fact, US Treasury bonds are some of the most stable financial instruments, because they are backed by the full faith and credit of the US government.
Income investors receive current income payments in the form of cash payouts like dividends or interest, from the entity in which they invest. This is often called “passive” income, since the investor doesn’t participate in operating the business, but receives income from them. In the case of a dividend-paying stock, for example, investors receive a portion of the company revenue paid out to the stockholder. Income investing is a type of fixed-income investment, which means companies pay investors on a predetermined schedule, such as monthly or quarterly. This approach is beneficial for the investor with an objective of a steady stream of income.
Income investing emphasizes generating steady current income and is suitable for investors whose aim is capital preservation with less risk. Income investing can also prevent the value of an investor’s holdings from being eroded by inflation. When inflation enters the economic picture, market prices of products and services rise, and investors usually flock to stable, income-producing investments. This shift increases demand for income investments and raises their value. The combination of price appreciation and steady income stream helps protect gains already made in other investments, such as those with growth objectives.
Growth investing differs from income investing in their primary objectives. Growth investors seek maximum capital appreciation, whereas income investors aim for investment income and capital preservation. Both investment approaches offer opportunities for reaching an investment objective, though in a different manner. Some investors find that a combination of growth and income investing help balance risk and reward. Finally, investors may find that shifting from growth investing to income investing over time provides the advantage of preserving gains while generating current income.
An investor has choices along the way to meet their objectives—growth or income—just as a skyscraper developer. For investors, it is important to understand the differences between growth and income and make suitable investments that match their time horizon, risk tolerance, and objectives. Those who know the characteristics of growth and income investments can use this understanding to grow their portfolios efficiently, as they make progress toward their investment goals.