The ultimate goal of Financial Independence is often the same for many: attaining freedom from financial constraints. But the path towards it can look very different for everyone who embarks on the journey. One approach that’s popular among some FIRE advocates, but polarising among others, is growth investing. This article dives into how growth investing works, its potential pros and cons, and how it could fit into a FIRE strategy.

What is growth investing?

The clue to growth investing’s premise is in its name. It’s an investing strategy that prioritises shares, industries or sectors expected to grow faster than other similar assets or the market overall.

The goal for growth investors is primarily capital appreciation , where the value of their investment increases significantly over time. They usually have less of a focus on dividend income , or they may allocate a smaller proportion of their portfolio to income-producing assets.

Some of the main growth industries include tech (think NVIDIA or Tesla in recent years), healthcare, emerging markets, and other industries experiencing rapid development. This is often thanks to technological innovation. But there are also growth assets that sit outside share investing, namely property . And, since markets are constantly fluctuating, growth industries can change alongside market conditions.

As far as share investing goes, there are a few characteristics of growth stocks. Lots of growth companies are fairly early in their journey, giving them plenty of room for future expansion, or they may have only just listed on the stock market. Growth companies often have higher price-to-earnings (P/E) ratios , meaning investors are paying more for each dollar of earnings. However, this doesn’t necessarily deter investors. Instead, many are happy to pay more to access the potential for future price increases. Growth companies also typically funnel most of their profits into growing the business rather than paying dividends .

The big trade-off for higher returns, however, is higher risk. Growth stocks are generally more volatile because their future earnings are uncertain and their success is contingent on their continued growth. This is just one of the things to consider with growth investing, but we’ll go deeper into the potential drawbacks further down.

How does it differ from value investing?

Growth investing and value investing are often compared, but the two differ quite significantly in their approach.

Where growth investing focuses on companies potentially poised for expansion, value investing specifically targets shares that appear to be undervalued by the market. They’re kind of like bargain buys that have good fundamentals but aren’t priced where they should be. Out of the two, value investing is generally seen as the more conservative approach because there’s less chance of overpaying for an asset.

There are several other differences between growth and value investing. You can check out our guide to value investing for more insight.

What are the potential advantages of growth investing?

Some of the reasons investors go for growth shares include:

• The potential for strong growth: This is obviously the primary prospective benefit of growth investing. As a company expands, growth stocks have the potential to deliver strong returns for investors
• Compounding returns: Those strong returns can be enhanced by consistently reinvesting earnings and taking advantage of compound growth. This is when you effectively make returns on your returns, leading to exponential growth over time. You can use our Compound Interest Calculator to get an idea of how this could look. However, the effectiveness of compounding is contingent on growth
• Portfolio diversification: Several investors include growth stocks as part of a diverse portfolio. Growth stocks can counterbalance more conservative investments and potentially enhance overall returns
• Lower barrier to entry: Some growth stocks are fairly low-priced given they’re still in the early stages of development. This means you may not need as much capital to invest
• Future large-cap stock potential: Many large-cap stocks start as small-caps. Take Amazon and Apple , for example. By investing in companies that are still in the early stages of their growth, you may be able to pick out one that turns into a market leader further down the track. This could result in substantial gains (but remember there are zero guarantees in investing, and you could just as easily lose your money)
• Contribution to long-term wealth-building: Below we’ll explore how growth investing could have a place in contributing to long-term wealth, especially for FIRE advocates . But the short of it is that holding on to a growth asset for a decent period of time could lead to capital gains

And what about the possible downsides?

As we already know, growth investing isn’t without its drawbacks. Here are some considerations to think about before investing:

• They’re riskier: Growth stocks are generally a lot more volatile than other assets because they’re much more susceptible to price fluctuations. This comes down to several reasons, including their sensitivity to market conditions like interest rate hikes and economic downturns; their higher valuations; and their dependence on future growth expectations. If you’ve got a lower risk tolerance , think about whether you could handle this kind of volatility
• Many are overvalued: Some growth stocks may be lower priced, but many are priced higher than they probably should be. If the market corrects and sentiment changes, those overvalued stocks can significantly drop in value
• There’s a low chance of dividend payments: For investors seeking passive income , growth stocks may not be an ideal choice. Most growth companies reinvest their profits into the company to fuel expansion rather than distributing them among shareholders
• You’ll need to hold them long-term: If you’re looking for rapid returns or short-term liquidity, know that growth stocks typically take a while to see decent growth. In the short term, returns are fairly limited
• That capital growth may not happen: For every stock that grows exponentially, there are many more that never reach their expected potential. If growth stocks don’t meet expectations, there’s often a sharp decline in value – which could lead to big losses
• They may not suit newer investors: Picking the right shares can be tricky, and even the most seasoned investors can struggle to discern which growth companies are likely to succeed. Growth companies often have minimal financial data available, making research difficult. Determining your entry and exit points with growth shares is also a challenge, and again, even expert investors have trouble timing the market
• They require more hands-on management: All of that research, market timing, performance monitoring and portfolio adjustment means more time and energy spent on managing your investments
• There’s a risk of overconcentration: Because growth investing often concentrates on certain sectors, like tech, investors who prioritise growth shares risk having too much exposure in one area. This means they’re highly susceptible to sector-specific volatility

What are the differences between growth investing and passive long-term investing?

While growth investing is absolutely a long-term game, it’s not exactly the same as passive long-term investing – which is the philosophy we subscribe to here at Pearler.

To sum up what we’ve learned so far, growth investing focuses on individual stocks with strong growth and capital appreciation potential. It also involves trying to time the market to maximise returns. The main drawback is higher risk as well as the need to constantly and vigilantly monitor your portfolio to try to mitigate losses.

Passive long-term investing is vastly more hands-off. Those who take this approach typically go for a diverse range of investments, including broad-market assets like ETFs , that aim to yield steady returns over the long term. These returns may be in the form of dividends, or they may be capital gains. Passive long-term investing is less about picking the right stocks and capitalising on market movements through frequent trading. Instead, it's about adopting a buy-and-hold strategy that sees investors through market cycles.

This approach can result in more modest returns, but it generally comes with lower risk and doesn’t require as much hands-on management.

How could growth investing fit into a Financial Independence strategy?

Financial Independence is all about accumulating sufficient wealth to comfortably live off. For lots of FIRE advocates, this freedom enables them to escape the constraints of the 9-to-5 and spend their time doing what they want .

There are many, many ways to achieve FIRE, but one of the most common approaches is to establish a diverse portfolio that generates enough passive income to cover living expenses. This is usually achieved through investments like dividend-paying stocks, real estate and super .

Growth investing doesn’t really sit within that framework, nor the realm of passive long-term investing. But that’s not to say it couldn’t be incorporated into someone’s FIRE strategy.

For one, the potential for substantial expansion could help someone accelerate their wealth more quickly and allow them to achieve their FIRE goals sooner. Especially given FIRE advocates usually work towards their goal for several years, or even decades, the long-term time horizon of growth stocks could fit into that timeframe rather neatly. In the case of successful investments, this approach also allows the power of compounding returns to really take effect.

That being said, the risks of growth investing that we ran through earlier absolutely shouldn’t be ignored. If you’re contemplating including growth investing in your FIRE strategy, you’ll want to consider its volatility associated and your risk tolerance. You should also think about the overall diversification of your portfolio , to help ensure this risk can be balanced with more stable investments. Lastly, you’ll want to do your best to stay informed if your growth investments hit any downturns and adjust accordingly.

So, should you try growth investing?

Unfortunately, we can’t answer that one for you. Growth investing does have its potential advantages, and could be a valuable part of a FIRE strategy. However, it does come with a fair amount of possible drawbacks – and the risk associated with growth investing may not suit all investors.

Always do your research into different investing strategies before committing, and read up on the many ways to reach FIRE before deciding your approach. You may find that a slower, but stabler, path towards it is much more your speed.

And if you’re ever unsure of a financial decision or need help navigating your investments, a licensed financial adviser can guide you.

Happy investing!