How to invest while balancing income and growth

The market has been outperformed by stocks that pay dividends

Income funds won't necessarily perform the best, though.

Historically, one of the most successful investment strategies has been income. A study by Ned Davis Research found that between 1973 and 2024, the average annualized return of dividend-paying stocks in the SandP 500 was 9 points, while non-dividend-paying stocks had an average return of 4 points. Furthermore, during market downturns, dividend payers provided greater protection and were less erratic. Stocks that paid dividends in the index fell 11% in 2022 when the S&P 500 fell more than 18%, while stocks that did not paid dividends lost 38%. S&P 500 earnings per share fell by 92% during the global financial crisis of 2007 - 2009, but dividends only decreased by 6%.

Numerous other studies reach a similar conclusion. Strong financial standing is one reason for this. Strong balance sheets, substantial economies of scale, and competitive advantages are characteristics of companies with the best dividend records. Unused money is reinvested, used to pay off debt, or used to repurchase stock.

Keep out of the income trap.

Investors must exercise caution when drawing conclusions from this, though. Businesses perform better not because they pay dividends but rather because they are prudent enough with their money to keep paying them. Yield should not be confused with quality or value. High dividend yield companies aren't always inexpensive or well-run enterprises. Since their dividends are high, the highest-yielding stocks actually frequently underperform the market over time. According to some research, the market should be divided into five groups based on yield, with the second-highest yielding group being the focus.

These types of pitfalls are frequently encountered by fund managers and income investors who are looking for yield. Since they have to stay up with the rest of the industry, active fund managers with an income mandate are especially at risk.

Many UK equity income managers will use the current yield of the FTSE 100, which is about 4 percent, as a benchmark for their portfolio. Because of this, they might have to allocate funds to stocks that aren't always the best but have the highest yields in order to keep their fund's yield stable.

Maintain a balance between growth and revenue.

Investors should think about funds that consider the total shareholder return, also referred to as the total shareholder yield, rather than depending only on the dividend yield. Businesses with more flexibility than those attempting to meet set dividend targets are those that return cash to shareholders through other means, such as debt repayment or stock buybacks.

If management so chooses, they can halt the payback of many debts and stop buybacks at any time. It is far riskier to go against dividend expectations. A long list of CEOs who had to resign after breaking their dividend pledges can be found.

Growth should also be considered by investors. Despite the effectiveness of dividends, a company's ability to pay out cash to investors is ultimately determined by its earnings growth. A fund that prioritizes growth over income may produce superior long-term results.

If you sell, say, 4 percent of your holding annually, you can still receive a consistent income from a fund that generates significant capital gains. If your funds are held outside of a tax wrapper, like an individual savings account (ISA), there may also be a tax benefit to this strategy because the top rate of capital gains tax is currently 28%, while the top rate for dividends is 33.4 percent.

We like the JPMorgan Global Growth and Income (LSE: JGGI) fund. An exchange-traded fund (ETF), like the Fidelity Global Quality Income ETF (LSE: FGQD), may be of interest to passive investors.