New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 21,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Growth Stocks or Value Stocks for Young Investors?

A young investor asks,

“I have read that a growth tilt is a good idea for a young investor with a long time until retirement. I’m 24 and consider myself risk tolerant. What do you think about using Vanguard’s Growth Index Fund instead of their Total Stock Market Index Fund?”

First, we need to back up a step. When categorizing investments, “growth” can mean either of two different things.

“Growth” as opposed to “Income”

The first possible meaning is a part of a classification system (used, for example, by Edward Jones, Dave Ramsey) in which investments are labeled as either growth, income, or growth-and-income. Using this terminology, most stocks and stock mutual funds would typically be categorized as “growth.” (High-dividend stocks would usually be categorized as growth-and-income.)

I suspect this is what your source meant with his/her suggestion that young investors should allocate a large part of their portfolios to growth investments. But, as it turns out, this growth-as-opposed-to-income characteristic is not exactly what the “growth” in Vanguard’s index fund and ETF names refers to.

“Growth” as opposed to “Value”

Fund companies can name their funds almost anything they want, but with regard to Vanguard’s index funds (and with regard to Morningstar’s classification system), when something says “growth,” that’s as opposed to “value.” And it refers to the fact that the fund owns primarily growth stocks instead of value stocks.

Growth stocks are those of companies whose profits are expected to grow more quickly than average. And value stocks are those of companies whose profits are expected to grow more slowly than average.

But the fact that growth companies are expected to grow more quickly than value companies does not mean that growth stocks are expected to earn higher returns than value stocks. This is because the higher-than-average expected growth in profits is already built into the price of growth stocks. A growth stock will generally only have above-average returns if the company’s profits grow more quickly than expected.

In other words, while growth companies are expected to grow more quickly than value companies, funds that own primarily growth stocks are not expected to grow any faster than their counterparts. (In fact, if anything, it’s the value funds that have higher expected returns.)

For example, Vanguard Small-Cap Growth Index Fund does not have higher expected returns than Vanguard Small-Cap Index Fund or Vanguard Small-Cap Value Index Fund. And Vanguard Growth Index Fund’s expected returns are no higher than those of Vanguard’s Total Stock Market Index Fund.

So, for a young investor, it’s possible that personal circumstances would make a tilt toward growth stocks advantageous. (For example, if you had reason to think that your job safety had an unusually strong correlation to value stock returns, you might want to tilt your portfolio away from them and toward growth stocks so as to reduce the likelihood of your portfolio crashing at the same time that you get laid off.) But such cases are not common. And a desire to increase the risk and expected return of your portfolio is not really a good reason to tilt toward growth stocks.

New to Investing? See My Related Book:

Book6FrontCoverTiltedBlue

Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less

Topics Covered in the Book:
  • Asset Allocation: Why it's so important, and how to determine your own,
  • How to to pick winning mutual funds,
  • Roth IRA vs. traditional IRA vs. 401(k),
  • Click here to see the full list.

A Testimonial:

"A wonderful book that tells its readers, with simple logical explanations, our Boglehead Philosophy for successful investing." - Taylor Larimore, author of The Bogleheads' Guide to Investing

Comments

  1. Mike,

    Typically I see the case for young investors to prefer Growth stocks framed in terms of the tax drag that Value or Income-generating stocks suffer in a taxable account. This may become more compelling if Congress ever decides to remove or reduce the favorable US tax treatment for long-term capital gains — so Warren Buffet can stop complaining that he is not paying his fair share of taxes!

    Thus there could be a case for tilting to Value stocks inside tax-deferred plans like 401-ks at the same time as tilting to low or no dividend Growth stocks outside them — if one is able to save more for retirement than one can fit into tax-advantaged accounts. What do you think?

  2. Dale, that would make sense to me.

  3. It’s also worth pointing out that if you are young you may not have a good sense of your risk tolerance. I tend to agree with Jim Otar that, for the first decade of investing, contributions matter way more than portfolio composition. New investors should probably be encouraged to go a bit more conservative than they might otherwise choose. Better to be a little conservative and not panic (i.e. suspend your contributions or cash out or something) than to be initially aggressive and make a mistake. It isn’t investment growth that will matter–it’s how much you have contributed.

    You’ll have a better sense of your tolerance after you’ve lived through some different types of markets. By that time, you’ll have a modest amount accumulated and portfolio composition will start being more important in your results.

  4. I’m in my mid-late 20s and my goal is income replacement, which I’m trying to achieve through investing in a number of assets – in terms of stocks that means using a value-based approach to choose good dividend-paying stocks. I’d be the first person to admit that this may be a daft approach and that I have a hell of a lot to learn about investing, but it’s interesting and educational (about investing and about my risk tolerance, as Don commented) and with a clearly defined target income, everything I invest is a positive move towards that target. It’s also good that as long as I continue to work, I don’t need the income and can re-invest it, so at some point in time it should become self-perpetuating. Websites and blogs like this are a big part of the education piece for me, so thanks for the effort you put into it.

    Best regards,

    Guy

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a registered investment advisor or representative thereof, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2021 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy

My new Social Security calculator (beta): Open Social Security