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Investor Decisions: Growth or Income?

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect

When most people invest in financial assets, they usually put their money into shares or bonds to meet their financial objectives such as retirement, saving for university, or buying a home. Certainly, every investor wants to make money, but what investment vehicles will make their money grow? That depends on the investor’s objectives, how long an investor has to invest, and their appetite for risk or what is termed their risk profile.

Consider two investors. In the first instance, you have someone who has a retirement time horizon of 15 years, while the second person is an investor nearing retirement age 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 more risk, and so will have more time to make up for possible losses. The investor nearing retirement is more concerned about preserving his/her capital and it follow that he/s will have less inclination to take on 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, better prospects for rewards come with more risk, and it follows that less risk is associated with lower returns.  

There are two main investment vehicles – growth investing and income investing.

Growth investing offers the investor an opportunity to realise substantial returns on investment. Growth investments are usually suitable for investors with a long-time horizon and have a high-risk tolerance since they will seek maximum capital appreciation.

Income investing offers the investor income from his/her investment holdings. These investments are designed to generate income and preserve capital. Income generated from investments usually come from a source such as a share dividend or bond interest payment. Companies raise funds for their business by issuing bonds, which are basically loans that pay investors a fixed rate of interest in exchange for the loan. Governments issue bonds, too. In fact, in Malta both corporate and government bonds are hugely popular since they provide a steady income to their bondholders. Government bonds are some of the most stable financial instruments, not just locally but also in developed countries because they are backed by the full faith and credit of the country’s government.

Income investors receive income payments in the form of cash payouts like dividends from shares or interest from bonds, from the particular entity in which they invest. This is often called “passive” income, since the investor is not participating in operating the business, but receives income from them. In the case of dividend-paying share investors they receive a portion of the company revenue paid out to shareholders. Fixed-income investments pay investors on a predetermined schedule, such as annually or semi-annually. 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. 

Growth investing differs from income investing mainly in terms of the primary objectives of the investment itself. 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. A good compromise would be a combination of growth and income, which help balance risk and reward.

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.

At MeDirect, the Financial Advisor will engage in discussions with the customer and ask the required questions to determine the client’s investment objectives and financial goals with the investor’s financial resources available; as well as the risk tolerance (which the client is comfortable with) and the risk capacity that client can afford.

From the discussions, the Advisor will also be able to determine whether the investor will require income from his/her investments. As a rule, the investment recommendation would be to invest in mutual funds. Continuing on our discussion on growth or income investing, there is a decision to be made – whether to buy the accumulation share class, which would mean that the net income from the fund would be reinvested back into the fund with no charge to re-invest. The other option – the ‘income’ share class – would pay out all of the fund’s net income to the client in cash. This would allow the investor to use the money towards other investments or for living expenses.

According to Mark Preskett, Investment Consultant for Morningstar Investment Management Europe, says “We would always advise clients to buy the accumulation share classes. With accumulation, the reinvestment of the dividends provides a large portion of your total returns.”

However, Preskett adds one caveat: you should choose the income share class if you are going to be relying on the fund’s income for your living expenses.

But that should normally only happen in retirement. Typically, one should buy funds with accumulation share classes throughout one’s working years, and then transitioning into income share classes when it is time to retire.

I came across some pros and cons for each option, which I would like to share with you:

Accumulation
Pros: Process is free of charge; occurs automatically; ideal for long-term goals like retirement. 
Cons: No regular earnings paid out.

Income or Distribution
Pros: Provides additional income on a regular basis; value rises over time.
Cons: Reinvesting a distribution pay-out would come with sales charges; lowers the value of a fund’s assets and funds growth do not match the rapid growth of accumulation.

It is therefore very important to consult your financial advisor about the benefits and drawbacks of accumulation and distribution (of income) from your investments and decide which one is best suited for you and your lifestyle, also bearing in mind the stage in life you are in.

 


The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The
information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information
obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.
MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services
Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

 

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