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Growth investing and value investing are two approaches to investing that present differing risks and potential rewards. Determining the best approach for you depends on your risk tolerance, time horizon and overall financial goals.
What Is Growth Investing?
Growth investing is a strategy that focuses on companies whose sales and profits are expected to outpace the overall market. Growth companies often reinvest their earnings into activities that will fuel growth rather than pay dividends. Even if these companies do pay dividends now, the primary investment focus is on the company's growth and the potential for larger future returns.
Investing in growth companies carries a moderate to high level of risk. Stock prices for growth companies are often high compared to the company's value. Yet, investors are often willing to pay these higher prices, even when the company is overvalued, because they believe the company has high growth potential. Growth and profits aren't a guarantee, however.
Growth stocks are often more volatile. Their prices may rise sharply when the company shares good news or positive earnings reports. On the other hand, prices may drop quickly in response to negative changes to the company's growth prospects.
Because it may take a few years to see success, growth companies make better long-term investments.
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Types of Growth Investments
There are three main types of growth investments.
- Growth funds: Mutual funds or exchange-traded funds (ETFs) that are heavily invested in growth companies
- Growth stocks: Stocks of companies with the potential for above-average earnings and revenue growth
- Small-cap stocks: Stocks of smaller companies that are often still in their initial phases of growth
What Is Value Investing?
Value investing focuses on companies whose stocks are underpriced relative to the company's fundamentals—earnings, cash flow and other financial metrics—in hopes that company's stock price will increase. Dividends may be important to some investors looking for cash flow, but they're not a requirement for a value investment.
Value investors are looking to purchase stocks at a discount, but that doesn't necessarily mean they're cheap. Investors simply look for buying opportunities based on mispricing. For instance, companies may simply be overlooked by the market or negative press may have led to superficial price drops, and they are still considered "value stocks."
Since they're priced below the market, value investments have lower risk but may still experience short-term market fluctuations. It may take several years for the market to recognize the company's value and push up the stock price. For this reason, investors often have a longer time horizon.
Types of Value Investments
There are three common types of value investments.
- Value funds: ETFs that are heavily invested in value companies
- Index funds: An ETF that tracks the returns of a market index
- Value stocks: A stock that trades below its value
Growth Investing vs. Value Investing
Growth investors are willing to pay higher prices for companies that are expected to grow faster than their industry or the overall market. By comparison, value investors take on less risk and instead look for companies whose stock prices are below their worth. Value investors aim to purchase stocks at a discount and later profit when the stock price rises.
Growth stocks tend to perform better in bull markets when interest rates are lower and companies can access low-cost financing to fuel their growth. Value stocks, on the other hand, typically perform better in bear markets when investors have lower confidence and focus on minimizing risk.
Because growth stocks are volatile and carry a great risk of loss, investors are willing to hold long enough to realize their growth potential (though this result is not guaranteed). Value stocks may experience price fluctuations, but are less volatile and have lower risk. Values investors typically hold long enough for the stock's price to match its value.
| Growth Investing vs. Value Investing | |
|---|---|
| Growth Investing | Value Investing |
| Focuses on companies that will outperform the market | Focuses on companies that are priced below the market |
| Moderate to high risk | Lower risk |
| Longer time horizon | Short to long time horizon |
| Performs better in bull markets | Performs better in bear markets |
| High volatility | Moderate volatility |
| Less likely to pay dividends | More likely to pay dividends |
How to Decide Which Approach to Investing Is Best for You
Deciding the best approach depends on several factors, including the current market conditions as well as your risk tolerance, time horizon and financial goals.
Growth investing may be the better option if you're not looking for income, can tolerate big price fluctuations and have time to wait to earn your money back after huge losses.
On the other hand, value investing may suit you better if you want to earn regular income from your portfolio, have a lower risk tolerance and prefer slow, steady growth.
Of course, you're not restricted to a single strategy. You can balance the two by diversifying your portfolio with a mix of both types of investments. Over time, you might adjust your portfolio mix based on market conditions, your current financial goals and your portfolio performance.
The Bottom Line
There's no single approach that works for everyone. Ultimately, your investment strategy may borrow from both strategies to manage risk and meet your long-term investment goals. If you're stuck, consider consulting with a financial advisor to assess your goals and create a personalized investment strategy.