To start this conversation, we first need to define Financial Independence .

Financial Independence is when an individual or household has sufficient personal wealth to live without having to work for their basic needs. This generally means having enough savings, investments, or passive income to cover living expenses for the rest of one’s life.

Key aspects of Financial Independence include:

1. Debt-free : No high-interest or burdensome debts.
2. Emergency fund : Savings to cover unexpected expenses.
3. Investment income : Sufficient income from investments or other passive sources to cover living expenses.
4. Budgeting and planning : Effective management of finances to ensure long-term sustainability.
5. Retirement planning : Having a plan in place to support oneself without relying on employment.

How do we calculate if we’ve reached Financial Independence? One common measure is the 4% rule. This rule states that people can withdraw 4% of their total portfolio one year, and then continue withdrawing the same amount, adjusted for inflation, each subsequent year. This theoretically means that once your share portfolio reaches 25x of your annual expenses, you have reached Financial Independence (because withdrawing 4% of a portfolio worth 25 times your annual expenses would cover those expenses). Read more on the 4% rule here: What is the 4% rule, where does it come from and does it apply to Australians?

Note that the term used for living off proceeds from your investments above is withdrawing ; that is intentional. You can withdraw funds from your portfolio one of two ways:

1. Selling down fractions of your portfolio periodically
2. Banking income or dividends (rather than reinvesting them)

So this means that regardless of whether your investments’ annual return mostly comes from capital growth or income, you can still set up a system that works once you’ve achieved Financial Independence. That said, there are pros and cons of having investments more heavily weighted one way vs another once you’ve reached Financial Independence. We’ll get into those shortly. Similarly, there are pros and cons of achieving Financial Independence with different investment weightings too. These are often called income-focused return strategies or capital growth-focused return strategies. We’ll get into the pros & cons of these as well.

General comparison: Capital growth vs income investment strategies to achieve Financial Independence

Potential advantages of a capital growth-focused Financial Independence strategy

1. Higher potential returns: Capital growth investments, like stocks or real estate, have often historically offered higher long-term returns compared to income-focused investments. This could potentially accelerate the timeline to Financial Independence by rapidly increasing the value of the portfolio.
2. Inflation protection: Statistically, growth-oriented assets tend to outpace inflation over time, preserving and potentially increasing the real value of the portfolio.
3. Compounding: Reinvesting earnings or gains can lead to exponential growth in the portfolio’s value over time, benefiting from the power of compounding. However, like all concepts covered in this article, this is contingent on positively performing investments.
4. Tax efficiency: Capital gains tax are deferred until assets are sold, allowing for tax-free compounding over time. Plus, in Australia if you hold assets for longer than 12 months, you may receive a 50% discount on capital gains. It's worth speaking to a licensed tax accountant to understand your specific situation.
5. Flexibility: Investors have the option to shift strategies as they approach or reach Financial Independence. They can, for example, gradually move from a growth-focused portfolio to one that generates more income as needed.

Potential advantages of an income-focused Financial Independence strategy

1. Comparatively stable cash flow: A positively performing income-focused strategy can potentially provide a steady stream of income through dividends, interest, or rental income. This could theoretically cover living expenses without the need to sell assets.
2. Comparatively lower volatility: Income-generating investments, such as bonds, dividend stocks, or real estate, are generally less volatile than growth-oriented assets. This makes them more suitable for more risk-averse investors or those nearing retirement. However, please note that no investment is risk-free.
3. Capital preservation: Since income is generated without needing to sell the underlying asset, the principal investment can be preserved, potentially reducing the risk of outliving your resources.
4. Reinvestment flexibility: Income can either be reinvested to grow the portfolio or used to fund living expenses, providing flexibility depending on the investor's financial situation and goals.
5. Easier planning: With a more predictable income stream, budgeting and financial planning can become simpler. This approach aligns well with traditional retirement strategies where regular income is needed to cover expenses.
6. Franking credits: In Australia, dividend investors receive franking credits, which take the form of a tax rebate. Franking credits are the government's way of ensuring Australians aren't doubly taxed for their investments – once at the company level, and again on dividend income. To learn more, check out our article on franking credits .

Summary

A capital growth-focused strategy may align more with investors seeking to maximise long-term returns, build wealth, and protect against inflation. It generally offers the potential for higher gains, but with greater volatility and reliance on asset appreciation.

An income-focused strategy may be better suited for those who prioritise stability, regular income, and lower risk, particularly as they near or enter retirement. It may offer a more predictable financial outlook but may limit the growth potential of the portfolio. On the flip side, it could theoretically be less advantageous for those in higher tax brackets, as they'd need to pay additional tax on dividend income.

Sharemarket comparison: share price growth vs dividend income stream investment strategies to achieve Financial Independence

If you extend the comparison above to investing in the sharemarket, then really, you’re comparing investing for share price appreciation (i.e. the value of the collective companies you’re invested in increasing in value), vs investing for dividends and dividend growth.

But, because you’re now talking about investing in the same or similar asset classes, the difference between focusing on dividends vs capital growth is much smaller.

Fundamentally, the total return profile of a large collection of high dividend-paying stocks vs a large collection of low dividend-paying stocks will be much more similar than buying stocks (income + capital gains) vs bonds (income-only), for example. Learn more: Total Return: what it is and why it matters .

Accumulation phase: Share price appreciation vs dividend reinvestment

For a capital growth-focused strategy in the accumulation phase, there is less pressure to have a fast and robust dividend reinvestment system as your wealth primarily grows through share price appreciation. This can mean you don’t need to actively manage and reinvest your earnings as much. However, the downside is that your portfolio is more exposed to market volatility as you’re earning. This can lead to potentially large fluctuations in your portfolio’s value, which is emotionally burdensome, particularly as your portfolio grows in value.

On the other hand, for a dividend-focused share investing strategy in the accumulation phase, there may be greater return stability as dividends have relatively less volatility than share prices (although dividends can also be volatile). However, this means that your dividend reinvestment system may benefit from being fast and robust – both procedurally and emotionally (i.e. you actually follow it). Without reinvestment, the potential for compounding returns is diminished, and the overall growth of your portfolio will be slower.

Maintenance phase: Sell down portfolio vs dividends

In the maintenance phase of Financial Independence, dividend-focused share investing has the advantage of potentially generating income without needing to sell down your assets. Your annual returns will also typically be less volatile due to dividends being relatively more stable than share prices (although again, dividends are never immune from volatility).

This may mean that, with all things being equal dividend-heavy portfolios may be slightly easier to manage in the maintenance phase than capital growth-heavy portfolios, both logistically and emotionally. Of course, this assumption is based on exclusively hypothetical factors. For tailored advice, speak to a financial adviser.

Achieving Financial Independence via sharemarket investing: What matters most

Assuming you’re investing in the sharemarket to achieve Financial Independence, in the grand scheme of things, it really doesn’t matter much whether you choose to invest for share price growth, or dividends and dividend growth.

What we believe matters more is that your investment portfolio is sufficiently diversified across industries and markets. If you’ve done this, it will mean you have some investments in capital growth-focused markets (e.g. US market) and some dividend heavy markets (e.g. AU market).

We have written many times about why we favour exchange-traded funds (ETFs) , and/or diversified ETFs for achieving Financial Independence. ETFs do this diversification for you.

Additionally, it’s really important you have a system in place which reflects your plan. Life can get busy. The sharemarket can get scary. You want your default to be to consistently invest regardless. For this an automated investing strategy may make your life easier. It’s also worth anticipating the emotional journey you will experience when the sharemarket gets volatile (it inevitably will) and how you will navigate this. Again, a set-and-forget automation strategy can help you here.

As your portfolio grows, emotions will too. You don’t want to have to look at the sharemarket every time you make an investment. Sticking to the plan is the key to Financial Independence, so ultimately, it's vital to choose a strategy which aligns with your goals and interests.

Happy investing!

Kurt