Since there is no savings at 40, should an investor look for growth stocks or value stocks?

As a general rule, I think investors should consider tilting their portfolios toward value stocks as they approach retirement. And this is true whether the desire is to build wealth or earn income.

A 40-year-old will not be eligible for a State Pension in the UK for another 28 years. And that means there is more time, which opens up more opportunities in terms of stock growth.

Growth and value

Investing in the stock market is about buying a stake in a company in the hope that one day it will do enough to provide a decent return. And there is a big difference between growth and value stocks.

The main difference is where the company will provide that refund. In general, value stocks that trade at lower multiples of sales and earnings offer greater returns in the near future.

The second difference is how much the business will provide in the long run. And for lower short-term profits, they often have a better chance of generating higher profits in the long run.

An investor who wants to retire in five years probably doesn’t have time to wait 20 or 30 years for the company to grow. But for someone with a long-term perspective, things may be different.

UK growth stock

Halma (LSE:HLMA) is a good example of this. I FTSE 100 the company has a market value of £10.5bn and made £333.5m in free cash flow last year – a return of just over 3%.

For a short-term investor, this may not be very attractive. The five-year UK government bond currently yields 4.2%.

To be able to offer investors a better return than this, Halma will need to increase its free cash flow by 10% per year. And that is far from confirmed.

Halma generates most of its growth by acquiring other businesses, which means it depends on the opportunities it presents. And there is a risk that they may not exist in five years time.

Investing for the long term

However, in 30 years, the equation becomes much better. The corresponding bond has a 5% yield, but only 3% annual growth from the business will see Halma generate more income.

That reduces the risk for investors. And while the company may be going through the lows of a five-year cycle in terms of acquisitions, I don’t expect this to continue until 2054.

Over the past ten years, Halma’s free cash flow per share has grown by 11.5% per year on average. Even if it controls half of this going forward, this should generate enough cash to support an annualized return of 8.4%.

This does not eliminate the risk of growing by buying – it is still possible to overpay due to poor judgment. But the investment equation makes more sense in the long run and is worth considering.

No savings? No problem…

Even if there is no savings, using part of your monthly income to invest in stocks can bring you excellent returns. And growth stocks can be a good choice for investors who think in decades, rather than years.

Investors must be prepared to wait for growth to emerge. But while I think those with a short retirement horizon should consider focusing on value stocks, 28 years is long enough to look for growth.