A young investor asks,
“I have read that a growth tilt is a good idea for a young investor with a long time until retirement. I’m 24 and consider myself risk tolerant. What do you think about using Vanguard’s Growth Index Fund instead of their Total Stock Market Index Fund?”
First, we need to back up a step. When categorizing investments, “growth” can mean either of two different things.
“Growth” as opposed to “Income”
The first possible meaning is a part of a classification system (used, for example, by Edward Jones, Dave Ramsey) in which investments are labeled as either growth, income, or growth-and-income. Using this terminology, most stocks and stock mutual funds would typically be categorized as “growth.” (High-dividend stocks would usually be categorized as growth-and-income.)
I suspect this is what your source meant with his/her suggestion that young investors should allocate a large part of their portfolios to growth investments. But, as it turns out, this growth-as-opposed-to-income characteristic is not exactly what the “growth” in Vanguard’s index fund and ETF names refers to.
“Growth” as opposed to “Value”
Fund companies can name their funds almost anything they want, but with regard to Vanguard’s index funds (and with regard to Morningstar’s classification system), when something says “growth,” that’s as opposed to “value.” And it refers to the fact that the fund owns primarily growth stocks instead of value stocks.
Growth stocks are those of companies whose profits are expected to grow more quickly than average. And value stocks are those of companies whose profits are expected to grow more slowly than average.
But the fact that growth companies are expected to grow more quickly than value companies does not mean that growth stocks are expected to earn higher returns than value stocks. This is because the higher-than-average expected growth in profits is already built into the price of growth stocks. A growth stock will generally only have above-average returns if the company’s profits grow more quickly than expected.
In other words, while growth companies are expected to grow more quickly than value companies, funds that own primarily growth stocks are not expected to grow any faster than their counterparts. (In fact, if anything, it’s the value funds that have higher expected returns.)
For example, Vanguard Small-Cap Growth Index Fund does not have higher expected returns than Vanguard Small-Cap Index Fund or Vanguard Small-Cap Value Index Fund. And Vanguard Growth Index Fund’s expected returns are no higher than those of Vanguard’s Total Stock Market Index Fund.
So, for a young investor, it’s possible that personal circumstances would make a tilt toward growth stocks advantageous. (For example, if you had reason to think that your job safety had an unusually strong correlation to value stock returns, you might want to tilt your portfolio away from them and toward growth stocks so as to reduce the likelihood of your portfolio crashing at the same time that you get laid off.) But such cases are not common. And a desire to increase the risk and expected return of your portfolio is not really a good reason to tilt toward growth stocks.