Dilemma: Income or Accumulation units?

Primrose

I am about to exchange some funds in my ISA portfolio for lower risk or to dump some poorer performers . Previously all income has been invested. In the next 18 months I may want to start taking income from some of these funds Should I buy income units instead of accumulation units? I am with Hargreaves Lansdown. Will I still be able to continue reinvesting dividends if I buy income units until I need to start actually drawing the income? Forgive the silly question but the differentiation between these two units still slightly confuses me. Idiot's guide please !

[Deleted User]

Hi,

here's what it says on HL,

• What is the difference between income and accumulation units?
• The class of unit held will affect the way income generated from the fund is treated. With income units, income is paid into your Vantage account as cash. This is then paid out, held on your account or reinvested depending on how you have instructed us to deal with income in your account. With accumulation units income is retained within the fund, although the number of units remains the same the price of each unit increases and hence the value of your holding rises.

dunstonh

I often use income units to pay the income into the cash account. Then you can rebalance the cash periodically. Plus, it keeps the float topped up so units are not sold and it allows you to monitor the capital gains situation (when unwrapped) much easier than with accumulation units.

There is no right or wrong here. Whatever it easiest.

Vortigern

dunstonh wrote: »

I often use income units to pay the income into the cash account. Then you can rebalance the cash periodically. Plus, it keeps the float topped up so units are not sold

Similar for me. HL will sell funds and charge a fee for doing so if there is not enough cash in your account to pay their fees. I switched some funds from accumulation to income to ensure that there is always cash available. I have my preference set to "hold cash on account." I can then re-invest manually (to rebalance)

jimjames

If the platform you use will reinvest for free there is no downside to inc units. One advantage of inc units is that you can easily see how much income they've generated which isn't so easy on acc units.

TrustyOven

I've been thinking about this too. I've got £610 in accumulation funds (yeah, just starting out with investing) but what annoys me with accumulation is that it doesn't buy me more units.

Dividends are paid per unit, and all accumulation units would do is increase in price. I'd still have the same number of units. Isn't that a slower path to building wealth than income units?

ie. the more units you have, the more dividends you get, the more units you can buy, the more dividends you get next time, the more you can buy next time etc.

Doesn't that feed the compounding circle faster than accumulation units?

So, for anyone on the path to FI, won't income units be king?

dunstonh

but what annoys me with accumulation is that it doesn't buy me more units.

Which is the point.

Dividends are paid per unit, and all accumulation units would do is increase in price. I'd still have the same number of units. Isn't that a slower path to building wealth than income units?

Which is higher? 5x4 or 4x5?

The end result is the same.

bowlhead99

TrustyOven wrote: »

I've been thinking about this too. I've got £610 in accumulation funds (yeah, just starting out with investing) but what annoys me with accumulation is that it doesn't buy me more units.

Dividends are paid per unit, and all accumulation units would do is increase in price. I'd still have the same number of units. Isn't that a slower path to building wealth than income units?

ie. the more units you have, the more dividends you get, the more units you can buy, the more dividends you get next time, the more you can buy next time etc.

Doesn't that feed the compounding circle faster than accumulation units?

So, for anyone on the path to FI, won't income units be king?

Think of it this way. A fund is split into two versions, inc and acc.

At the start, the Inc fund is 10,000 units of £100 each. So is the Acc fund. The both have a million to spend.

And lets say you are one of the unitholders, and you hold 1000 units of each, for £100k investment in each.

Both funds go out and invest their money and make an amount of income equal to 5% of their starting million as well as their underlying investments going up in value by 10% of their starting million.

At the end of the year they both have £1,100,000 of investments and £50,000 in the bank from their income. Total asset value of each fund is £1,150,000 and they still have 10,000 units in issue, so each unit is now worth £115 each instead of £100. In both funds, your 1000 units are worth £115,000.

Then, we get to ex-dividend day. The income version pays out its £50,000 in cash. So the holders of the 10,000 units get £5 each, which to you with your 1000 units is £5,000. But now the fund only has £1,100,000 of assets because it just spent all its cash on paying a dividend. The unitholders of the income fund are now holding 10,000 units worth only £110 each, plus £5 each cash in their hand, while the unitholders of the accumulation fund still have 10,000 units worth £115 each because they have received no dividend.

So let's say that you decide to re-invest your £5000 income distribution, to buy more units, while all the other investors in the income fund choose to keep their income to spend on living or on buying other funds. You want the income fund to issue you new units for your £5000, and the value of a unit is £110 each, so they will issue you 45.4545 units. Now their total units in issue is 10,045.4545, because only you bought new units and nobody else bothered.

Together with the 1000 units of the Inc fund that you already owned, the new units issued to you now gives you a total of 1045.4545 units. They're worth £110 each. So as you expect, this is a total investment value of £115,000. Just like you have in the acc fund, which never paid out the dividends, where you own 1000 units at £115.

OK, so let's roll it forward one year and assume the same returns.

The Acc fund started the year with £1,100,000 of investments and £50k of cash which it never paid out as dividends. It throws the £50k back into investment opportunities, investing the total £1,150,000 for another year. In doing this it makes a 10% gain (total investments will now be worth £1,265,000) as well as receiving 5% of the £1,150,000 as an income (£57500 of cash in its bank account). At the end of the year, in total it will have 1,322,500 total assets. And because it still has 10000 units in issue, each unit will be valued at £132.25. You will still own 1000 of them, so your overall investment is worth £132,250.

Now look at the Inc fund. It started the year with £1,100,000 and only £5000 cash because most of the investors kept their income and only you chose to spend the income in buying more units. So, it will spend the £5000 on buying new investments, and altogether it will be investing £1,105,000 for a year. In doing this, it should make 10% gain on investment values (taking total investments to £1,215,500) and should get a 5% income (generating cash of 5% of £1,105,000 = £55,250).

Altogether the Inc fund has £1,215,500 of investments and 55,250 of cash, making total net assets of 1,270,750. As we know it has 10,045.4545 total units in issue of , each unit must be worth £126.50 each.

So you are sitting there at the end of the second year, with 1000 units at £132.25 each (£132,250) in the Acc fund, and 1045.4545 at £126.50 each in the Inc fund (£132,250).

So, your value is exactly the same. Right about that point, we go ex-dividend again.

In the Inc fund, the cash of £55,250 is paid out between the 10045.4545 unit holders and so for your holding of 1045.4545 units you'll get £5750 cash dividend. You can choose to reinvest it or not, it's up to you.

Meanwhile in the Acc fund, they have £57500 of cash. And you know you have an entitlement to some of it, because you own 1000 of the 10,000 units. In fact, your entitlement is £5,750, just like you could have received in cash in the Inc fund. But in the Acc fund, they never pay it out to you, they just tell you it's being reinvested.

So you can repeat this as many years as you like, but if the two versions of the fund have the same underlying investment strategy, and you keep manually buying more shares with the income you take from the Inc fund, you will generate the exact same returns and have the exact same overall value in the two funds.

A bit that sometimes confuses people is that in the Acc fund you never get sent any cash, but you are still 'getting' dividends in the shape of having more valuable units. As we saw, the virtual dividends, per unit, are higher with the Acc fund as time goes on, so it doesn't matter that you have fewer units. Because your entitlement to the income is the same. The dividend is simply a larger amount per share on the fund that issued fewer units.

If you are a high rate taxpayer who needs to pay tax on their dividend income, or you are making enough profits over time to worry about capital gains taxes, it is probably simpler to use Inc funds: physically receive the cash and keep a nice track of what dividends you got, and what price you chose to buy back in at, so you can easily calculate your income taxes and gains taxes.

If you are investing in an ISA or SIPP this is kinda irrelevant, but still useful to know what sort of rough yield is being generated and how much relates to income versus capital growth. An as Dunstonh suggests, having a cash float being generated helps you rebalance between different funds in your portfolio quite easily without needing to sell some of one thing to top up another thing.

So, (very) long story short, you might have a preference to receive income for spending or rebalancing or paying your platform fees without needing to sell any units, and helping the tax calculations go down easier. In this case, use an INC fund.
OR you might have a preference for all the income to just roll up in an ACC fund so you never bother touching it.

Either way, performance should be the same with either version which Dunstonh summed up rather more succinctly than me

dunstonh wrote: »

Which is higher? 5x4 or 4x5?

The end result is the same.

Primrose

Vortigern. Can you or somebody p,ease tell me where (if you are using the H-L site) you can set your preference to hold cash on account as I can't find it anywhere in the portfolio preferences section. Also can you specify which finds to treat in this way? I am beginning to realise I,m a real amateur at this kind of thing and need to wise up.

[Deleted User]

Hi,

in My Portfolio click to view your Nisa, click cash tab, then income account, on right hand side you will see, Amend your income instructions.

Vortigern

Primrose wrote: »

Vortigern. Can you or somebody p,ease tell me where (if you are using the H-L site) you can set your preference to hold cash on account as I can't find it anywhere in the portfolio preferences section. Also can you specify which finds to treat in this way? I am beginning to realise I,m a real amateur at this kind of thing and need to wise up.

Apologies for late reply. Frugalmcdugal has answered your question. This post is just to add that you can't specify your income preference on a per fund basis; the preference applies to the whole account.

You can however choose to hold a mix of INCome and ACCumulation funds. The INC units pay their income into the cash account, to be distributed according to your preference; the ACC units re-invest their income automatically. HTH