Which are best for passive income, dividend shares or growth shares?

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I invest in shares in order to set up a passive income stream for my later years. So should I stick to dividend shares that pay cash regularly, or might I get a better return by including some growth shares?

There may appear to be an easy answer. But I suspect that the champion of long-term investing, Warren Buffett, might not agree.

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The obvious beauty of shares that pay dividends is the income will just keep dropping into my account without my having to lift a finger.

Dividend shares

With most UK dividend shares, the cash is paid out twice a year – often with the biggest portion at year end, with a smaller interim dividend. Some of the bigger FTSE 100 companies pay their dividends quarterly, spreading it out more evenly over the year.

Income from dividend shares can be a bit lumpy, and depends to a degree on when each company ends its year and pays the cash. But I reckon it’s reasonably easy to maintain a regular monthly income. If I keep the equivalent of, say, three months worth of cash withdrawals sitting in my account, that should even things out.

Growth shares

So what’s all this about growth shares and Warren Buffett? He has the sharpest eye for cash generative companies I have ever seen. But his own investment company of him, Berkshire Hathawayhas never paid a dividend.

No, since Buffett took charge back in 1965, he hasn’t shelled out a single cent in dividends. For someone who puts so much priority on cash flow, why not? Well, do investors trust their cash to him so he can hand some of it back every year?

No, they want him to use it to generate compounded returns year after year. And the result speaks for itself. Up until 2021, Berkshire Hathaway has generated an average return of 20% per year. That is however, not necessarily an indicator of future returns.

Which is better?

Does the fact that none of it was converted into dividends mean I should turn my nose up at that huge return? And be happy with, say, the 4% or so per year that I might get from FTSE 100 dividends?

Turning returns from growth shares into income is easy enough. I would just need to sell some at regular intervals. It’s simply a case of doing that myself rather than dividend shares just handing me the cash.

Growth shares can be more volatile, mind. In 2008, for example, even Berkshire Hathaway made a negative return of -31.8%. And then in 2015 we saw -12.5%. But between 1964 and 2021, the S&P 500 produced an overall gain of 30,000% (with dividends included). Berkshire, by contrast, returned 3.6m percent in share price gains.

Return is what counts

To cope with down years, I would keep a buffer of maybe a year of income in my account, topping it up by selling some shares every quarter while prices remain good. And that’s about the most active management I reckon I’d need for a retirement portfolio of mixed dividend shares and growth shares.

What really matters is the total return, not how it is delivered.

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