Investment funds are often made available in two classes: income and accumulation.1 Unlike train carriages, one class isn’t better than the other. In a contest, income vs accumulation funds always ends in a draw. That’s because they’re functionally identical, except for how they pay dividends or interest to their investors. 

For brevity, I’ll only refer to dividends below. But the accumulation vs income funds rules apply equally to interest payments, too. 

And everything we’ll discuss today also applies to Exchange Traded Funds (ETFs) as well as Unit Trusts and OEICs.

Note that ETFs sometimes replace the terms income and accumulation with distributing and capitalising. 

The difference between income and accumulation funds

• The income class of a fund pays dividends out as ever-popular cash. This goes directly to your brokerage account shortly after the fund’s payment date. From there, you can spend them, reinvest them, or just watch the cash pile up. 

• The accumulation class of a fund reinvests your dividends back into itself. This buys you more of the fund, increases the value of your holding, and compounds your return. 

The graphic below shows you the income vs accumulation fund effect of reinvesting a dividend, as opposed to taking the money.

The 5p dividend raises the value of a single unit of your accumulation fund to £1.05. 

Note, you don’t receive additional units or shares. The reinvested dividend simply increases the value of every accumulation unit (or share) that you own. 

Meanwhile, the income version of the fund hands out its dividends. In fact the value of inc units of a fund actually drops slightly when dividends are stripped from its net asset value, ready to be distributed to the lucky fund owners. 

Over time, the accumulation share class price of a fund gradually climbs higher than the income class. The retained dividends increase the capital value of these acc units. 

But income owners do benefit instead from regular cash paydays. These can be spent on life’s little pleasures, bills – or on other investments.

Income vs accumulation fund returns

Happily, you get exactly the same investing bang for your buck with either class of fund. 

The chart below illustrates the point. It shows the 10-year returns for a FTSE All-Share index fund in both accumulation (or acc) and income (inc) varieties:

Source: Trustnet 

The line on the graph shows identical returns for both funds when dividends are reinvested in the income version.  

In this scenario, the income fund’s performance matches its accumulation sibling over comparable timeframes. (Bar the occasional rounding error.)

However if the income fund’s dividends are spent, then its value falls behind. You can see this in the next chart:

Now we can see how badly the income fund trails (red line) when we don’t reinvest its dividends. 

The blue line of the accumulation version slowly diverges from the identical starting point as those re-invested dividends boost its growth like little rockets. 

And so a yawning acc vs inc fund gap opens up over time. 

The acc fund demonstrates the power of compounding dividends as and when they’re earned, retained, and reinvested.

Whereas income units leave all that up to you.

Still, there’s no right or wrong choice when it comes to selecting income vs accumulation funds. 

How you use your dividends depends on your financial objectives and investing preferences. 

But your choice does have knock-on effects. Let’s quickly run through the key reasons why you might pick income or accumulation funds.

Accumulation vs income funds: pros and cons

Why choose acc or inc funds? Here’s why:

Spending now vs spending later

Pick income funds if you want to use dividends as spending money. That’s particularly useful for retirees who want to live off their income. 

Your inc fund payouts effectively provide a rule-of-thumb spending guideline. And you limit the hassle factor of periodically selling off funds to meet your expenses. 

Accumulation funds are ideal if you’re building your pot – particularly in tax shelters. Your income is automatically rolled up into a snowball of future wealth. You needn’t lift a finger. 

That’s appealing given the passive investing benefits of investing on auto-pilot.

Convenience has a value all of its own in investing. Viewed through this lens, your accumulation vs income fund choice is the one that best fits your lifestyle. 

Controlling investment costs

If you need to sell units or shares to meet everyday expenses, then regular income fund cash distributions can reduce costs. 

When you withdraw dividends from your account, you avoid paying dealing fees compared to selling down your investments. 

Some people also like to use their spare dividends to pay platform fees. 

Contrarily, if you plan to reinvest your dividends then acc funds enable you to avoid:

• Reinvestment costs
• FX fees
• The bid-offer spread 

Your money is also put to work in the market at the earliest possible moment. That’s liable to be positive for your returns in the long-term.

Obviously you can reinvest dividends manually, too. But inevitably there’s a lag.

Fund managers must pay your broker the dividend. Your brokers must process the payment.

And then real-life sometimes gets in the way before you can do anything with the cash lying dormant in your account.

Psychology

Many inc fund investors like the feeling of watching dividends roll in as live cash-money in their account.

There’s no doubt the ‘Ch-ching!’ morale boost is real. It can help you stay motivated during a long investing journey towards a faraway objective like FIRE. 

The countervailing advantage of accumulation funds is that automatically invested dividends juice your returns without any danger of you self-sabotaging. 

You can’t, for example, divert the cash into a wildly overvalued investment because you’ve been swept along by the madness of crowds. 

And you won’t fail to reinvest into an asset on sale just because it’s taken a pounding lately.

The best habits are the ones that don’t cost willpower.

Acc vs inc fund taxation

When it comes to paying tax the critical point is that there’s essentially no difference between income and accumulation funds. 

Your dividend tax, income tax, and capital gains tax liabilities are the same. 

The main issue is you need to keep good records if you hold accumulation funds outside of tax shelters. 

Our post covering tax on reinvested dividends in accumulation funds explains the extra step you need to take to protect yourself from being overtaxed.

If you don’t take that step, you could be unfairly taxed twice on the interaction between capital gains and reinvested dividends. 

Your tax certificates and/or dividend statements from your broker should provide you with the paperwork you need to fill out your self-assessment form. 

The tax certificate tots up the dividends you receive from your accumulation funds in a given tax year.

Hassle your broker if you’re not receiving this certificate after the first tax year you held your funds.

Note: you won’t get, nor need, a tax certificate if your funds are held within an ISA or SIPP. Hurrah!

Some people investing outside of tax shelters find it easier just to hold income funds. 

Others – incorrectly – believe that receiving inc fund dividends will save them capital gains tax that could be triggered if they sell acc fund units to meet expenses. 

But this is not the case. Accumulation fund dividends do not count towards capital gains. 

Therefore you can sell acc units or shares equal to the dividends you receive without incurring a capital gain.

Does switching from accumulation to income funds trigger capital gains tax?

Switching between accumulation and income share classes within the same fund may not trigger capital gains tax – but it depends on how the tax rules are interpreted. 

Snippets from HMRC tax manuals in circulation appear to suggest that such a switch doesn’t trigger a capital gains tax event. 

But much depends on gnomic HMRC guidance that’s laced with technical terms and depends on opaque interactions between different pieces of tax legislation. 

The tax manuals are also silent on what happens if you trade between an accumulating and distributing ETF. 

The bottom line: get expert tax advice beforehand if you’re concerned about the capital gains tax consequences of a switch.

Again, capital gains are not an issue if your accumulation or income funds (or ETFs) are snugly secured in your tax shelters.    

The difference between income and accumulation fund names

How can you spot an accumulating fund or ETF? The clue is usually in the name. Look out for these abbreviations:

• Acc
• A
• C
• Cap

C is for capitalising which is another term for accumulating. 

Income funds or ETFs may also be termed distributing and tip you the wink like this:

• Inc
• D
• Dis
• Dist

Read more on Monevator about decoding fund names. You can also learn more about accumulation funds – including how to uncover their dividend history!

Take it steady,

The Accumulator

1. Funds with ‘inc’ in the title indicate income units. Meanwhile ‘acc’ indicates accumulation. [↩]

The Finumus household is enjoying its first interaction with the student loan scheme in 30 years.

Our eldest is (hopefully) off to university in the autumn. Our youngest will be going two years later.

Just to keep things interesting, the government is completely overhauling the student loans system for the 2023 intake. Hence we get to do a little natural experiment with our finances. 

We’ll skip over the debate about whether university is a good use of time and money. Our children are going, and that’s that.

The question for now is: “Should they borrow the money or not?”

Enter the student loan

Let’s first acknowledge how fortunate we are that whether or not to take the student loan is even a question.

Most families don’t have a choice. The only way their children can afford to go to university is with a loan. This makes the value-for-money calculation that much harder for them.

But our kids go to public (that is, private) school. The annual cost of their education will actually be marginally reduced once they are at university, compared to the current status quo, even if they borrow nothing.

So we can afford to support them – in terms of both fees and maintenance.

However we’re going to have them borrow the maximum amount of student loan.

Like everyone else they’ll be saddled with crippling student debt when they graduate!

Does this seem a bit mean to you?

Let’s look at the reasoning.

How the student finance system works

Students are expected to borrow money from the government’s student finance scheme to fund their university education.

They can borrow to cover all the fees (£9,250 p.a. ) and also some element of maintenance – ranging from about £4,500 p.a. to about £12,000 p.a. – depending on various complicated criteria, including family income.

(This is if you reside in England and are attending university in England. Otherwise the rules are more complicated).

Repayment works like a hypothecated, limited amount, graduate tax.

• Under the current scheme, you have to pay an additional 9% income tax over a certain threshold, until you’ve paid the loan back or until 30 years has passed. At that point the student loan is written off. Interest charged is roughly RPI+3%.

• With the new (2023) scheme, the earnings threshold is lower, the interest rate is lower (roughly RPI), and the term is 40 years.

Crucially, for us, you can also repay early with no redemption penalty. 

According to the IFS, the 2023 changes will mean that far more graduates will repay their loan in full (75% vs 25%) but those students who would be paying it back in full under both systems (that is, higher earners) will benefit under the new scheme. This is because the interest rate is lower. 

More lower earners, who might have escaped repayment under the old system, will be caught by the new lower earnings threshold. These people will end up worse off. 

The change then is highly regressive – if you are measuring only within graduates.

If you’re thinking about the wider tax base, it’s not quite so clear – because arguably the change reduces the tax burden currently falling on those who don’t go to university. 

The stated intent of the changes is to encourage students to read subjects that lead to higher-paying careers.

Any side effect of discouraging some from going at all the government doubtless sees as an extra bonus. After all, universities teach young people to think for themselves, and turn out lefty-liberal-remainer-voting ‘experts’.

But this is a finance blog not a political one.

Let’s take the system as we find it and – well – think for ourselves. 

Gaming the system

Back in the halcyon days of positive real interest rates, low asset prices and cheap student debt – when your correspondent was at university – gaming the system was easy.

The student loan was only required to cover maintenance (fees were paid by the state – imagine) and the interest rate charged was very low. 

Although my parents insisted that they didn’t want me to get into debt and hence paid for my maintenance, I of course borrowed the money anyway and used it to speculate in the stock market.

I could even have stuck it in the bank and come out ahead, too. (Admittedly you did have to avoid the temptation to spend it all in the union bar). 

But things are more complicated under today’s shifting regime. The loan is dearer than it was for me, for a start.

However even if you can afford to sidestep the student loan altogether and just have your kids pay-as-you-go (PAYG), you might still want them to get into hock by maxing out their student loan, and then you (as a family) stash away the equivalent sum borrowed elsewhere.

To be clear, we’re suggesting that on graduation, our graduate will be in one of two positions:

Which one is best? The net positions seem identical.

However there are two reasons why you might prefer to borrow: 

1. Positive carry: it makes sense to take out the student loan if you can earn a low-risk post-tax return that’s higher than the interest rate on the loan.
2. Loan write-off: if our young graduate isn’t ever going to have to pay the loan back, then that’s a win.

We’re not going to spend much time on the first reason. Earning a sufficiently high yet near-risk-free rate of return will be extremely difficult under the current scheme, although it might just be possible under the 2023 scheme, with its lower interest rate.

Your required rate of return also depends on your individual tax circumstances. It’ll be harder if you’re already filling up everyone’s ISAs and SIPPs to the max, for example, because your return will be taxed. You’ll have to do your own maths, based on your personal circumstances.

Borrowing also adds unnecessary complexity and leverage to the family’s affairs, so that’s a demerit.

All things considered, for us the positive carry argument doesn’t stand on its own.

It comes down to the second reason. Are my kids really going to have to pay the loan back? 

Reversible decisions

As Jeff Bezos famously pointed out in his 1997 Amazon shareholder letter, it’s much easier to make reversible decisions.

The student loan can be paid back at any time. This means borrowing the money is an easily reversible decision.

At any time after graduation our family can collapse the ‘Borrow’ row in my table above into the ‘PAYG’ row. We simply take money from our savings and write a cheque to the Student Loans Company to do so.

However we can’t go the other way round. Once we’ve not-borrowed the money, there’s no going back and asking to borrow it again.

Therefore, we should borrow the money. It’s what’s known in finance parlance as a free ‘real option’:

We’d be foolish not to take it.

Little darlings

If you’re in a position to make a decision like this, you’re likely over-estimating the probability that your child will have to back the loan in full.

We know that between 75% (current scheme) and 25% (new scheme) of graduates won’t repay the loan in full.

But of course, your kids will, right?

You’re likely a high-earning university graduate yourself.

So you imagine that your children are going to have fulfilling, well-remunerated careers.

They may well do so. But they might not.

Stuff you don’t want to think about

I was fortunate enough to attend one of Britain’s most elite universities – the sort of place that churns out Prime Ministers and Fortune 500 CEOs.

At a recent gathering of some old college friends, conversation turned to the range of outcomes that our cohort of about 150 had experienced. This led me to consider whether we all would have paid back the student loan if we’d been borrowing under today’s rules back then. 

In our sample there’s a large rump of successful middle-class high-earners, a few centimillionaires, and a bus driver. All of them would likely all be paying back their loans.

Then we have people who have worked their whole lives for charities on fairly low pay – mostly women. Some had a fairly short career because they decided to prioritize family. Others became artists or poets.

They likely wouldn’t be paying back their whole loan. 

We also have a few who wouldn’t have had to repay any of the loan at all. The ones who suffered mental and physical health problems, addiction, family break-ups, legal problems, or just unlucky employment choices that materially impacted their ability to earn. Their careers sort of petered out before they really got going. 

Finally, and I’m sorry to bring this up, but it is a reality – we have those who didn’t make it at all.

One didn’t get to graduation. Three died before they were 30: traffic accident, drowning, cancer. 

I concede this is a set of anecdotes, not a representative sample. But there it is. Sometimes things don’t go to plan. It doesn’t matter how middle-class you are, how good a university you go to, or how much money you have. Nobody is immune to these possibilities. 

More happily, we also had a few who permanently emigrated. They wouldn’t need to pay back their loan. (I know nowadays in theory you would, but in practice if you’re permanently emigrating then what are they gonna do about it?)

They’ll change the rules

So there you have it. As a family, you should have your children borrow the money, while you squirrel away in a savings account whatever you would have spent. Then simply decide later whether to pay it back.

You could choose to repay the loan the day they graduate or a decade later. Taking out the student loan is an easily-reversed decision that provides a fairly low-cost insurance policy against bad outcomes for your child. 

Finally there’s the other side of the equation. The rules will change – probably for the worse, but possibly for the better.

The whole system could be replaced with a graduate tax, which they’d be paying anyway. This would likely incorporate some sort of forgiveness of the existing debt as part of the process.

The fact is 30-40 years is a very long time. Anything could happen. The US paused loan repayments during the pandemic. Some politicians are now advocating student loan forgiveness.  

Just whatever you do, don’t let your spunky offspring splurge the borrowed money away in a future resurgence of YOLO madness.

If you enjoyed this, follow Finumus on Twitter or read his other articles for Monevator.

What caught my eye this week.

Another miserable week in the markets. Thanks in part to shocking updates from US retail giants Target and Walmart, the all-important S&P 500 index briefly joined the growthier Nasdaq in bear market territory on Friday, having dropped 20% from its all-time high before a mild end-of-day rally.

Meanwhile inflation in the UK hit 9% and the Bank of England won both plaudits and wooden spoons for candidly admitting there’s not a lot it can (constructively) do about it.

Getting on for a year into this regime change, and some readers continue to insist there’s nothing to see here. Nor in the bond market, which has endured its biggest, sharpest sell-off for decades, if not ever.

I’m not sure why the denial, apart from the currency weakness that I talked about last week clouding the picture. I think we can agree markets rose an awful lot in 2020 or that super low interest rates spurred some ‘questionable’ antics without downplaying the reality check that’s now taking place.

Veteran commentator Josh Brown describes it as:

one of the most treacherous environments I have ever seen, and I traded during the dot com meltdown, 9/11, Enron and Tyco and WorldCom and Lehman and LTCM and Madoff and the debt ceiling downgrade and the Asian currency crisis and the European debt crisis and Gangnam Style and the pandemic lockdowns and Zika and Ebola and SARS and Bird Flu and Hoof and Mouth and all sorts of other shit.

Not just traded for myself but answered to others about their money, in real-time, during all of it. Those environments were tough. This one’s impossible.

I even spotted the once famously bearish hedge fund manager Hugh Hendry making waves on Twitter, like some wintry White Walker reappearing from legend in Game of Thrones.

Hendry was appropriately uber-gloomy. The last time he got a mention on Monevator it marked the bottom of the financial crisis crash. But I’m not confident of a repeat, omen-wise.

(For one thing: has anyone seen the especially portentous Nouriel Roubini?)

Once upon a time

In that last big bear market I wrote a lot about how and why I bought stocks in downturns.

Eventually, those investments turn out to be among the best you will ever make.

But it can be hard to see cheaper prices as your opportunity to profit when your portfolio is shedding ballast faster than the Met issuing fines in Downing Street.

So I thought I’d point newer investors to a comment I uncovered while digging for this week’s Archive-ator link below.

Doing so, I came across 2008-era-me offering unsolicited advice as usual, only this time on someone else’s blog: Accumulating Money.

At the time, January 2008, that blogger’s household net worth was just shy of $72,000.

Accumulating Money knew buying at lower prices should be good, long-term.

But they also recognized they faced a challenge after a ‘brutal start’ to 2008.

The Goldilocks scenario

I was there in 2008 and it was indeed tough going. The year got a lot worse before things started getting better, too.

But we have an advantage, sitting here in 2022. We know how the story ended.

In fact, it turns out we can skip to the most recent net worth update from Accumulating Money, March 2022, where we learn their number is now…

…$1.5 million!

Yep, despite the gloom in 2008 and a lot of terrible headlines in-between, A.M. has multiplied their wealth more than 20-fold. And that’s despite the market mauling their retirement accounts in recent months.

To be honest I’m not surprised by this figure. It more or less tracks my own trajectory over the past 15 years.

But I thought perhaps those who haven’t yet lived through a few stock market storms might be reassured, by seeing what’s come before.

Are you sitting comfortably?

Of course every market downturn is different. To me this one looks more challenging for the likes of Monevator readers, at least with hindsight, thanks to its higher inflation and rising interest rates.

I expect both to start coming down, but that’s partly because I expect demand destruction and at least a mild recession. (As do a few of those sellers of Target and Walmart shares I’d wager.)

On the other hand, if inflation and rates do keep on rising indefinitely… well.

Either way, we know the playbook. Try to earn more. Live below your means. Save as much as you can without derailing your life.

Then invest in equities for the long-term, probably through low-cost global index funds.

Just promise to come back in 15 years to tell us how it went!

Take these time-tested steps towards financial freedom and I believe your tale will also have a happy ending.

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