This is a question that I like to answer in this article.
Many times, we see the enormous returns by growth stocks and we think to ourselves, maybe I should just invest in growth stocks instead. I mean, look at TSLA, AMZN, SE...
...all that enormous returns that I have been missing out!
Now now, I cannot deny that. It is exhilarating to see our portfolio skyrocketing because of growth stocks - I personally hold some growth stocks of my own.
However, it is also important to emphasize this. An investing strategy is not a one-size-fits-all approach - as it really depends on our lifestyle and quite honestly our personality.
So let's dive in and explore which strategy actually suits you best.
Growth Investing Is Like A Baby
Growth stocks are typically smaller size companies and that have huge amount of potential for growth.
Its kinda like a baby with tons of growth potential. But yet at the same time, it is very vulnerable, tend to fall down from time to time. If you notice for growth stocks, they tend to have increasing revenue but yet they are still reporting negative earnings.
There is a big difference between revenue and earnings. Revenue is what is collected from the sales of their products and services, while earnings are what remains from the revenue after deducting all the expenses.
You might be wondering - then why do people still want to invest in such a company that is making a loss in net earnings every single quarter?
The answer? Potential.
It is very much like why parents choose to send their kids to schools and sometimes even pays exorbitant amounts for extra tuitions. Well, because they see a potential in their children and want to realise them.
This is the same for growth companies. The better you understand about the companies, the more you learn about their potential. This involves studying their business models, customer bases, future growth plans and most importantly, competency of management to execute on their plans. When growth investors see this potential, this is what gives them the conviction to invest their money, and every quarter, they will monitor the progress of their companies - much like how parents monitor the progress of their kids.
It all sounds good and rosy - but very few people are actually capable of executing growth investing effectively.
Why? The lack of conviction.
Like I said earlier, growth companies are like babies - so they tend to be quite shaky. A little set back, and the market tend to overreact and start to sell off the shares. For example, one of these growth stocks just fell by 17% in a single day.
While the market starts the sell off, this is something that most investors are not able to stomach. Imagine having a $10,000 position on this stock, and you lost $2,713 on paper. An investor with no conviction is going to start to panic and thoughts like this will form in his/her head:
"Omg, is it going to fall further...should I sell the stocks? Maybe half? Or should I add more? But I already invested $10,000 - what if it falls further? Could the company be failing to execute its growth plans?"
This usually happens to people who blindly copy the growth investor's without understanding the reason for investing in the first place. You can copy a person's investment, but you can never copy his conviction (unless you did the same due diligence).
Meanwhile, during a market selloff, the real growth investor is popping his champagne and adding more positions to his/her portfolio (after re-verifying the fundamentals of the company, of course.)
The key takeaway?
If you are the sort of investor who cannot manage huge volatility swings in your portfolio - it might be a tell tale sign that you have not done enough research to build up conviction on your investments. Behind every stock is a business - if you truly understand the business well, market selloffs are merely an opportunity disguise in the face of danger.
"But Gin, I work almost 12 hours a day, there's no way I can read and research all about the growth companies that I am investing in!"
I fully appreciate that - researching and building conviction on a company is hard work. The alternative then, is to join a community of like-minded growth investors who are always actively discussing about these growth companies. Remember that, you are the average of the people around you. If you are surrounded by people who are growth investors - then quite naturally, by the law of diffusion - slowly, you become an expert growth investor as well.
However, at the end of the day - you have to do your own independent research because that really helps you build conviction. When it comes to investing, never become a blind mouse, and get eaten during a market selloff.
Why I Am A Value Investor
Well, for a start, I have to admit I am not really someone that do tons of deep-dive research - so when it comes to conviction in investing in growth stocks, I am not the best person. This is why, the growth stocks in my portfolio, are kept at less than 30% of my portfolio. The remaining are still quality value companies using both stocks and options.
The second thing is with value quality companies, I am able to create cash flow from my investments by selling call options.
"Gin, why can't you sell call options with growth stocks?"
Well, this is an important question. Remember that I said growth stocks are stocks with potential. And the moment, more and more people recognise the potential, the share price can shoot up unexpectedly.
When we sell call options, we are promising to sell 100 shares at a specified strike price, and in return, we collect option premium.
So imagine I bought 100 shares of stock ABC at $100, and decided to sell a call option at a strike price of $110, and collected $200 in option premium.
And suddenly, the growth stock skyrocketed to $150. It means that I could have made $5000, but because of my sell call options -> I am forced to sell it at $110 instead. And it is really not uncommon for growth to suddenly spike up - but it is much less likely for value quality stocks. This is why I am able to sell call options on these companies without worrying much of it being exercised. And even if it was exercised, it is unlikely that the share price skyrocketed by a huge amount.
Why can't I just keep growth stocks and not choose to sell call options then?
Well, you can do that but it depends on your investment objective.
The whole reason of my portfolio is for financial freedom, i.e. it is designed to be a portfolio to grow steadily, while providing me cash flow to pay for my expenses - and personally tried it myself, and found out that selling call options still seems to work best only for quality value companies.
So what are quality value companies? Well, these companies are already profitable companies with a proven track record of increasing their earnings that passes my 8-Point Checklist. And because they have a track record, they tend to be less volatile.
Conviction = Returns
Now, whether you choose growth investing or value investing - if you don't have conviction, you wouldn't make money. And I am going to show you mathematically why this is the case.
Let's say that I have a net worth of $1,000,000.
If I had no conviction in growth stocks, what do you think its the percentage of $100,000 that I would allocate to growth stocks? Well, its definitely not 100%. So let's say it is at 20%, and growth stock portfolio increase by 50% in a year.
20% X $1,000,000 X 0.5 =$100,000
But if I had a very high conviction for value quality companies, I can allocate up to even 90% of my $100,000 into value quality companies. Let's say value stocks makes around 20% in a year.
90% X $1,000,000 X 0.20 =$180,000
In short, the conviction that you have in your investment instrument will directly affect the allocation amount you are willing to put.
So if you really want to reap the benefits of growth stocks, make sure that you are willing to do your deep-dive research so that you can increase your allocation.
And if you are anything like me, who doesn't really like to do tons of research and prefer to invest in proven companies with track record, it is very easy to build conviction with quality value companies.
At the end of the day, you need to find the investment instrument that you are able to find conviction to invest the most of your net worth. We need to make money work for us, and the worst thing to do is to let any surplus money lying in the bank.
The Bottom Line
The bottom line is really to find an investment strategy that suits you so that you are able to have conviction to invest most of your net worth. To me, as much as possible, I never want to leave a surplus of money in the bank - I will always deploy the cash into investments in order to create an even larger portfolio that will give me even more cash flow in the future.