Accumulation vs income funds: what’s the difference?

An introduction to the different types

There are several different fund types that offer accumulating and income options. There are open-ended investment companies (OEICs), unit trusts, and exchange-traded funds (ETFs). This guide will focus on ETFs which trade on the London Stock Exchange. Understanding how they work is important when including them in your investing strategies​.

How do accumulation funds work?

Accumulation funds don’t distribute dividends or interest to shareholders. Rather, when payments are received by the fund, they reinvest it into more assets. The investor still benefits from the dividends because that value has been added to overall value of the fund that they hold, but they don’t ever physically receive distributions/income until they sell the fund.

The advantage of this is that the investor doesn’t have to reinvest money distributed to them. It is done automatically. This allows for compounding to start right away. Having the capital automatically reinvested can also help to save on commissions costs because the investor doesn’t need to make a trade to reinvest funds received.

Accumulating funds may not be good for people who want regular income. The only way to get cash flow from an accumulating fund is to sell. An example of an accumulating fund is the iShares S&P 500 GBP Hedged UCITS ETF (IGUS). The fund doesn’t pay out any dividends. Instead, it automatically reinvests them in the stocks it holds.

How do income or distribution funds work?

Distributing funds, also called income funds, pay out dividends and interest to shareholders. This is typically done monthly, quarterly, or yearly, depending on the fund. Investors who want income will favour income funds, as they can use the distributions however they wish.

The downside is that if the investor does want to reinvest some or all of the proceeds, they will need to do this manually. An example of a distributing fund is the UBS Factor MSCI USA Quality UCITS (GBP Hedged) ETF (UQLT). The fund pays out dividends twice per year.

Which are better: accumulation or income funds?

One type of fund isn’t better than another. In fact, assuming an investor in an income (distributing) fund reinvests their dividends, the performance of an accumulating and distributing fund will be nearly identical.

Which one to invest in is a personal choice based on whether you want to receive the income or have it automatically reinvested. For those planning to reinvest the funds anyway, an accumulating fund will save on commission costs because you don’t have to reinvest the funds yourself. If you plan to reinvest yourself (distributing), you can reinvest in the same ETF or other stocks/ETFs. If putting money into individual stocks, learn how to invest in stocks​ before doing so.

Here’s a chart showing the difference between income and accumulation fund performance. This assumes the fund makes 10% per year and dividends are reinvested. Taxes are ignored and are discussed later.

Accumulating ETF

Distributing ETF

The distributing investor would also have £1.63 in cash. A cash balance is created when an investor must reinvest their own capital and can only buy full shares. If an investor were allowed to buy partial shares, then there would be no cash balance left over after reinvesting the dividends. Thus, the total return, including cash, is £25,936.55 for the investor in the distributing ETF.

As you can see, the two funds end up performing nearly identically if you are reinvesting dividends yourself.

List of the best-performing accumulation funds

These are the top-performing accumulating funds listed on the London Stock Exchange over the last five years, representing the return for passive investing. ETFs that are nearly identical to the top performer in the category have been excluded (this is so there aren’t five S&P 500 Information technology ETFs, which are all similar).

All these funds are priced in USD and thus the five-year (22 December 2016 to 22 December 2021) returns are in USD, of which the data is sourced from justETF.

Please remember that past performance is not a reliable indicator of future results.

For investors wanting to focus on ETFs that are priced in GBP, or are GBP hedged, here are the top performers in that category. Since the funds are priced or hedged to GBP, the returns are in GBP.

List of the best-performing income or distribution funds

These are the top-performing income funds listed on the London Stock Exchange over the last five years. ETFs that are nearly identical to the top performer in the category have been excluded. All these funds are priced in USD and thus the five-year (22 December 2016 to 22 December 2021) returns are in USD, of which the data is sourced from justETF.

Please remember that past performance is not a reliable indicator of future results.

For investors wanting to focus on ETFs that are priced in GBP, or are GBP hedged, here are the top performers in that category. Since the funds are priced or hedged to GBP, the returns are in GBP.

How is income taxed?

If shares are held inside a stocks and shares ISA​, and the portfolio then gains, dividends are not taxed. If the funds are held outside an ISA account or general investment account, then dividends/distributions are taxed in the year received at your dividend tax rate.

Some countries don’t charge taxes on dividends that aren’t received. In the UK, that is not the case. Taxes are paid on dividends earned, even if they are not paid out.

For UK citizens, there is no tax difference between an accumulating and distributing fund. The only difference is that with one, you have the cash and can pay taxes out of it, and with the other, you need to come up with cash from somewhere else to pay the taxes on the dividends (which are still in the fund).