In what I call serious investing, the main type of stocks that would be purchased when one is young, loosely defined as age 12 to maybe 45, would be growth stocks. These are stocks of companies that have room to grow and expand. The reason that these are the stocks to own while you are young is that they will provide the greatest return provided you have a long time to hold them.
Think of it this way: Let’s say you own a business that sells roses at a subway stop. Everyday you could expect to sell a certain number of flowers to people coming through. It would be different people most days, but on average you would sell a certain amount, to the point that after a few weeks you would know how many to bring to avoid having a lot left over. There would be periods, of course, like Valentine’s day and Mother’s day season where you would sell more. You might also sell more in the spring since that is when people are thinking of flowers and because there are a lot of people starting to date in the spring. Those changes in sales would be predictable after a few years of selling and would just become part of your expected income for the year.
The amount of money you would be taking home would be fairly constant. There might be sometimes when you are able to find flowers for lower prices and then maybe make a little more. There might also be changes in the population a little, where there are more people coming through the subway and therefore you end up selling more roses, but in general the amount of income you would take home would be fairly constant. This would be comforting in a way because it was predictable. You would know that you would have enough money to pay your rent and put food on the table because you had been able to do so every month. Maybe you would save money from the months where sales were particularly high, or use those months to pay for the bills that come up less often, like insurance and vacations, since the income in the other months would not be enough.
While your reliable income would be nice, the amount of income you could get by taking a few more risks would be greater. Assuming you had a reasonable number of competitors, such that people could go elsewhere to buy flowers if you started charging too much, you would be lucky to make more than a few percent of profit. This limits the amount you can make. If you were to expand your business line, maybe selling potted plants in addition to roses, or starting a delivery service to offices nearby, or setting up stands in other subway stations, you could grow your revenues and profits by more than you could through simple change in population and efficiencies alone.
To grow and expand your business you would be taking on more risk, however, and you would have some failures. You might spend a lot of time setting up a flower stand in another subway station, only to discover that people there like tulips instead of roses. You might find that office deliveries result in a lot of flowers being damaged, adding to your costs. You would also need to take on additional workers which comes with its own costs and unknowns.
You would know that with time you would find things that worked and caused your profits to grow. You might see your profits drop one year because you were spending more money expanding the business, but in future years those expansions would add to your profits. The risks you were taking would reduce the ability to make predictable profits each week. Over long periods of time, however, you could expect profits to increase.
Growth stocks are the same way. They are growing and expanding, meaning that over long periods of time they will provide a greater return than will income stocks that are established businesses with predictable earnings. Because you need to hold them for long periods of time, you need to make sure you have enough time for them to realize the fruits of the investments they are making.
You would not want to put money you need within a year or two into a growth stock because the chances of it being up in a year or two would be about the same as the chances of it being down. If you had 15 years, however, and had the choice between buying three income stocks and buying three growth stocks, you’d be better off with the growth stocks because you would get a better return unless you have really bad luck with your choices. When you are 20 and have 45 or 50 years until retirement, you can afford to put your money into growth stocks and wait for them to mature. In fact, you would be giving up a lot of return if you concentrated in income stocks and bonds instead. You would see fewer fluctuations in the value of your portfolio, but you would also see it grow considerably more slowly.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.