Retirement Investing: Growth vs Income?

TJB24

Dear All,

I have a mathematical question with regards to compounding; i.e. for long term retirement investing, is it better to target high growth assets, or high income?

My understanding is that compounding only occurs because income/interest is reinvested with the original capital, so future income/interest is on both, then multiplies over the long term.

High growth stocks - assuming zero dividends - would not have compounding, as there is no added capital to the principal for future interest.

My question then is, over a 40 year term, what would be the greater amount:

Income Option

£200 invested each month, achieving a fixed 5% annual dividend, over 40 years

= £299,120.91 (using compound interest calculator).

Growth Option

£200 invested each month, achieving an average 15% annual growth in stock price.

= ??

Obviously the returns would not be fixed, but I'm interested how you calculate the cumulative growth assuming regular investments over the long term. The best policy is likely to always be diversification between strategies, but I'd like to know the theory or how to calculate this projection and compare to two results.

Many thanks!

Anonymous101

TJB24 wrote: »

Dear All,

I have a mathematical question with regards to compounding; i.e. for long term retirement investing, is it better to target high growth assets, or high income?

My understanding is that compounding only occurs because income/interest is reinvested with the original capital, so future income/interest is on both, then multiplies over the long term.

High growth stocks - assuming zero dividends - would not have compounding, as there is no added capital to the principal for future interest.

My question then is, over a 40 year term, what would be the greater amount:

Income Option

£200 invested each month, achieving a fixed 5% annual dividend, over 40 years

= £299,120.91 (using compound interest calculator).

Growth Option

£200 invested each month, achieving an average 15% annual growth in capital price.

= ??

Obviously the returns would not be fixed, but I'm interested how you calculate the cumulative growth assuming regular investments over the long term. The best policy is likely to always be diversification between strategies, but I'd like to know the theory or how to calculate this projection and compare to two results.

Many thanks!

Unless I've read your question incorrectly the two options are essentially the same.


Option 1: £200 investments pays 10% in year one (£20) so you have £220. Reinvested in year two pays further 10% (£22) giving you a total of £242 and so on


Option 2: You invest £200 which grows at 10% in year one so is worth £220. In year two it grows a further 10% so is now worth £242.


There's no difference between the two options given the same rate of growth / dividend.

El_Torro

To answer your specific question, just use a regular savings calculator, for example this one: https://www.thecalculatorsite.com/finance/calculators/savings-calculators.php

By my calculations investing £200 a month for 40 years with a 15% annual growth rate would end up with £6,280,751.09

I'm not sure why you're using these numbers, even the most optimistic of forecasters wouldn't dream that the average annual growth for equities over the next 40 years will be 15%.

TJB24

El_Torro wrote: »

To answer your specific question, just use a regular savings calculator, for example this one: https://www.thecalculatorsite.com/finance/calculators/savings-calculators.php

By my calculations investing £200 a month for 40 years with a 15% annual growth rate would end up with £6,280,751.09

I'm not sure why you're using these numbers, even the most optimistic of forecasters wouldn't dream that the average annual growth for equities over the next 40 years will be 15%.

Thanks for both replies. I'm quite possibly getting confused myself.

To give a practical example, I'm thinking which is likely to end up more profitable - investing in high growth funds such as Lindsell Train Global Equity, Fundsmith etc who have returned that kind of average, versus investing in a bond fund such as Royal Sterling Extra Yield, which pays out 6% interest.

Income buys more fund units whilst growth just increases the unit's value - is there any mathematical difference?

El_Torro

The question of whether growth funds are better than income funds is a wide one, covered extensively in other threads. I'll give it a stab here though.

Firstly, we don't know how quickly an Accumulation fund is going to grow, compared to a fund that specialises in giving its investors a high yield of income.

One thing we can say though is that funds that specialise in income are often doing this at the expense of growth. So they invest in companies that focus on giving dividends at the detriment of long term growth of the shares. GSK being one good example.

The view I personally take is that I just want a fund that grows, whether the growth is due to reinvested dividends or growth in the share price is of no real material difference to me. That's why I don't have much faith in funds that focus on income. They are potentially ignoring companies who's share price grows rapidly but give little or no dividend.

This is an easy path for me to take, especially since I am probably at least 20 years away from retirement. When I do start drawing down from my investments my current plan is not to change my philosophy too much though. I plan to keep a large cash buffer (about 3 years worth). That way I can draw from my cash when investments are low and top up my cash buffer when investments are high.

MarkCarnage

You have posed this question as a mathematical one, then gone on in a subsequent comment to suggest that the growth option involves an equity growth fund, and the income one, a high yield bond fund. It's no longer a mathematical question....as you are comparing two very different entities.

Even sticking with an equity growth fund as a the sole example, his supposes that the return from reinvesting income in units in this fund is the same as the return that the investor can achieve by reinvesting the income.

To state that high growth stocks would not have compounding as there is zero dividends is neither strictly factually accurate (many growth stocks pay a dividend, it's just not a very high yield), nor financially accurate as high growth companies tend to reinvest retained earnings.

provided that it remains attractive to reinvest these because of high expected rates of return. The compounding in this case is internal.
Warren Buffett defends Berkshire Hathaway not paying dividends on the grounds that it's a lot more economically and tax efficient (for investors) to reinvest cash within the businesses held than pay it out to investors. They can always sell a share or two if they need 'income'.

Back to your original question, is it better to target high growth or high income assets for retirement. The answer will depend on the time horizon and the value placed on certainty of income required. If you invest in bond funds, you will almost certainly have a lower total return outcome over any meaningful time period, but have a high probability of a predictable and secure level of income. If you invest in high growth equity funds you will probably have a higher total return outcome but very little certainty or predictability over income, which will be lower initially too. Equity income funds somewhere in the middle.

TJB24

El_Torro wrote: »

The question of whether growth funds are better than income funds is a wide one, covered extensively in other threads. I'll give it a stab here though.

Firstly, we don't know how quickly an Accumulation fund is going to grow, compared to a fund that specialises in giving its investors a high yield of income.

One thing we can say though is that funds that specialise in income are often doing this at the expense of growth. So they invest in companies that focus on giving dividends at the detriment of long term growth of the shares. GSK being one good example.

The view I personally take is that I just want a fund that grows, whether the growth is due to reinvested dividends or growth in the share price is of no real material difference to me. That's why I don't have much faith in funds that focus on income. They are potentially ignoring companies who's share price grows rapidly but give little or no dividend.

This is an easy path for me to take, especially since I am probably at least 20 years away from retirement. When I do start drawing down from my investments my current plan is not to change my philosophy too much though. I plan to keep a large cash buffer (about 3 years worth). That way I can draw from my cash when investments are low and top up my cash buffer when investments are high.

MarkCarnage wrote: »

You have posed this question as a mathematical one, then gone on in a subsequent comment to suggest that the growth option involves an equity growth fund, and the income one, a high yield bond fund. It's no longer a mathematical question....as you are comparing two very different entities.

Even sticking with an equity growth fund as a the sole example, his supposes that the return from reinvesting income in units in this fund is the same as the return that the investor can achieve by reinvesting the income.

To state that high growth stocks would not have compounding as there is zero dividends is neither strictly factually accurate (many growth stocks pay a dividend, it's just not a very high yield), nor financially accurate as high growth companies tend to reinvest retained earnings.

provided that it remains attractive to reinvest these because of high expected rates of return. The compounding in this case is internal.
Warren Buffett defends Berkshire Hathaway not paying dividends on the grounds that it's a lot more economically and tax efficient (for investors) to reinvest cash within the businesses held than pay it out to investors. They can always sell a share or two if they need 'income'.

Back to your original question, is it better to target high growth or high income assets for retirement. The answer will depend on the time horizon and the value placed on certainty of income required. If you invest in bond funds, you will almost certainly have a lower total return outcome over any meaningful time period, but have a high probability of a predictable and secure level of income. If you invest in high growth equity funds you will probably have a higher total return outcome but very little certainty or predictability over income, which will be lower initially too. Equity income funds somewhere in the middle.

Just wanted to say thanks to both of you for your replies - very helpful and clears up my thinking.