What are Dividends
When we say income from funds this is usually in the form of dividends. A dividend is simply the amount of money which a company gives to its investors from their profit. By owning 100’s if not 1000’s of companies inside a fund you can earn a little slice of profit from all of these companies. Now it must be noted that it is not compulsory for companies to pay a dividend and some do not. When they do funds pool this money together. This money is then paid as a dividend to you usually quarterly, semi-yearly or yearly dependent on the fund. How this dividend is paid to you is where the sub classes of accumulating or income comes into play.
Income Funds
This is the classic version of a dividend. The money is sent to your broker/investing platform and deposited as cash. You can then decide what to do with this money. You could reinvest it in the shares it came from, invest it in other investments or withdraw it and use it however you wish.
An income fund can usually be identified by the letters Inc or Dist. Dist simply stands for distributing i.e. they will distribute this income to you.
Accumulating Funds
You may see the abbreviation Acc in your fund name. This stands for accumulating and is the other sub-class. Instead of the money coming as a cash deposit into your account it will instead be automatically reinvested back into the fund. This doesn’t purchase more shares as you wont see the number of shares you own rise but instead the value of each share will increase. Over long periods this will help maximise growth via compounding.
Income vs Accumulating
There are advantages and disadvantages to both versions but both will give you similar underlying results as its only how you get your dividends which changes.
More flexibility
With income/distribution funds you can choose what you do with the money. This means when you have a larger amounts and gain significant dividends you could use it as a second income stream. You can also choose to reinvest the money or use it to buy other investments to diversify your portfolio. In the end this choice is up to you and this flexibility is a big advantage of an income fund.
Compounding
On the other hand you may not want all these options and just choose to reinvest this income to capitalise on the compounding effect. If this is the case the best way to do this is to choose the accumulating version as this occurs automatically. This is why it is best for new investors to choose an accumulating fund as it forces good habits ensuring they are reinvesting.
Recommended Reading: Understand the power of Compounding, it could just change your life.
Automating Dividends
Some platforms also offer automatic dividends reinvesting functions. This is available in Trading212 for instance if you have your fund inside a pie. This can be a good idea if you want the flexibility of an income fund but for the current period want to reinvest this money to keep the compounding machine rolling. This stops you forgetting about reinvesting this money so it can keep earning for you.
Fees
There can be less fees with accumulating funds depending on your platform/broker. Some platforms charge a fee to buy funds. By using your dividends to reinvest you could therefore inadvertently be ensuring yourself a worse return. This is another reason why it is very important to assess which platform you are with and whether it is right for you.
Recommended Reading: Investment Platforms how to find the best platform for you!
Tax Implications
In the UK if these investments are held in an ISA or SIPP any dividends will be exempt of tax. If they are held in a general investment account you may be required to pay tax such as capital gains or dividend tax. Currently the dividend allowance in the UK is £500 per tax year. If you exceed this you will have to pay a dividend tax of 8.75% for basic rate tax payers or 33.75% for higher rate. When you sell these funds you may also be liable to pay capital gains tax if you exceed your allowance that year. These additional fees can really eat into your returns so it does pay to be tax efficient.
In the end the type of fund you choose is down to you and your style of investing. This is a personal choice but I hope this information will help you make the best decision for you. Happy reinvesting!
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
