Investment funds of the Unit Trust and OEIC persuasion generally come in two flavours. There’s the good old-fashioned income flavour, and there’s also the self-inflating, high fat accumulation flavour.1
The difference between the two is simple, subtle and useful. But it can be as confusing as identical twins who part their hair on opposite sides.
The difference between income and accumulation units boils down to this:
- The income class of a fund pays out dividends and other income as cash. The money goes directly into your broker or bank account – with any luck shortly after the fund’s distribution date.
A welcome morale boost it is, too. If you’re in the withdrawal phase of your investment life (that is, you’re a spender!) then income units are typically for you.
- The accumulation class does not shower you with lovely money. Instead it hangs on to your dues and reinvests them directly back into the fund. This buys you more shares and compounds your return.
Accumulation units are dull, boring and not nearly so nice as finding a little cash in your trading account every so often.
All the same, accumulation units gift you discipline without effort. That can prove hugely uplifting in the long-term. Reinvested dividends are a major factor in total returns.
Accumulation units defeat the enemy within
You can reinvest dividends paid out from income units, too, but you’re always prey to the temptation to divert them into some shorter-term cause. (Such as having fun right now.)
The advantage of accumulation units is that the devil-in-you has no chance to make mischief. The income is rolled up into the runaway snowball of future wealth. You’ll barely even miss it.
In contrast, reinvest yourself and – aside from the potential self-sabotage already mentioned – you may lose a slice of your income to trading costs:
- Initial charges
- Brokerage reinvestment charges
- The bid-offer spread
Accumulation units side-step all that.
True, it won’t make any difference if you’re a smart passive investor who buys funds that don’t incur those kind of fees.
For example, the index funds used in Monevator’s Slow and Steady passive portfolio shouldn’t attract any upfront trading charges. Therefore you don’t save by using the accumulation version.
Automatically reinvesting dividends in some funds may be cheaper though, and ‘capitalising’ ETFs will also benefit from lower costs.
(‘Capitalising’ is ETF-speak for accumulation units. ETFs that pay out dividends are usually termed ‘distributing’.)
Show me the money!
By the way, if – like the great Wall Street financier John D. Rockefeller – your only thrill in life is seeing your dividends rolling in, you needn’t entirely miss out with accumulation funds.
You are still due the same dividends that the equivalent income unit holder enjoys.
By hunting about with some online tools you can see what dividends you earned – before they were rolled up into your accumulation units.
The same but different
When I try to explain accumulation units to friends (I seem to have less of those than I used to), they often go cross-eyed the moment the price differential comes up:
- Accumulation units cost more than income units.
- This does not make income units more attractive than accumulation units.
- Both classes of fund will produce identical returns in the future.
At launch, the accumulation class and income class of any given fund are identically priced. But over time, the accumulation units have retained dividends in the fund. Meanwhile the income units have handed them out.
The retained dividends have purchased more shares for the accumulation class of the fund and thus increased the value of every unit held. Yet when you buy into a fund, you’ll get the same bang for your buck from accumulation units as from income units.
Imagine the Monevator FTSE Human Folly index tracker fund:
- The accumulation units are priced at £2
- The income units are priced at £1
Let’s suppose the fund goes up 10%.2
- The accumulation units are now worth £2.20
- The income units are now worth £1.10
If you had spent £2 on two income units instead of one accumulation unit, your cash return would have been identical at 20p.
The only real performance difference is that accumulation units will without doubt be compounding your dividends as and when they’re earned, retained, and reinvested. Income units leave it all up to you.
Finally, please note that contrary to popular opinion, holding accumulation units instead of income units does not enable you to sidestep income tax.
The taxman doesn’t care that the dividends you earned were automatically rolled up. The dividend income earned by your accumulation units is liable for tax. The taxman is due his cut.
Shelter your investments in the tax-repelling shield of an ISA or pension to avoid paying income tax on your dividends, whether from accumulation units or income units.
This will protect the tax scythe from cutting down your long-term returns.
Take it steady,
- Funds with ‘inc’ in the title indicate income units. Meanwhile ‘acc’ indicates accumulation. [↩]
- Remember we are talking about the capital appreciation of the underlying holdings owned by your fund here. In contrast, a 10% gain due to income would either be paid out by an income unit or reinvested by an accumulation unit, as per the natty picture above. [↩]