Compounding Effects

Some people don't understand the term ACC!

Cheers fj

richtips86 wrote: »

Over the last year I've started dipping my toes into investing in funds (well, building up a sum in VLS 100 Acc) and as I've been doing so, I feel there's something fundamental that I don't understand.

Everything you read states, time in the market rather than timing the market which I'm fully onboard to benefit from the associated effects of compounding. I understand compounding in the sense of interest, but I am struggling with investments.

Assume I bought 100 units in VLS100 Acc on 1 January 2016 and do not buy anything else for 20yrs. By 1 Jan 2036, I'm right in thinking I'd still have 100 units? However, I'd expect the overall value of the funds to increase by x? Where is the compounding? Is it behind the scenes so to speak which results in the overall value of the fund increasing exponentially? I think I struggle, because I feel for my investment "to compound", in my 1st year, my investment is 100 units, year 2 103.5 units etc.

I'm know I'm asking a very basic question, but any insights would be gratefully received.

Cheers, Rich

You can invest in accumulation or income units, the former keep the growth within the units, the latter pay it out.

The net effect from each alternative should be the same, income pays out whereas accumulation keeps the income within the fund. So if you choose the income fund and reinvest the income receive the net amount will be pretty much the same, there may be minor differences in timings of reinvested income, charges etc

So after your nominal twenty years you might still have 100 accumulation units but if you bought at £100 per unit they might now be worth £200 per unit. If you bought the income version and reinvented the dividend you'd have the same value, say £20000, but the unit price would be lower, so you might have 133 units worth approx £166 each.

The way in which you hold the units doesn't affect the potential tax liability, so if you buy unwrapped, ie outside an USA or pension, you have a potential income tax liability in dividends and capital gains tax liability in growth. For that reason many people find it easier to buy income units for unwrapped investments as it makes tracking I mime and growth easier, accumulation is probably easier and better in an isa or pension.