Dilemma: Income or Accumulation units?

Primrose

I had great difficulty initially in finding the Cash tab at first ecause I was looking at the My overall Portfolio section where it did not appear because I am still one of those people who have separate account sections for old PEPs, Mini ISAs and the later ISAs. Can anybody think of any practical reason why I should contiinue to keep them separated like this?

My reasoning was that if I wanted to take income from only part of my Portfolio at first, and then gradually increase it, I could take income from one one section of the portfolio ie from the old Peps section only, leaving the mini ISAs and later Isas sections to continue having income reinvested until a later date. However it appears from the H-L wording about taking income that this may not be possible. Can anybody confirm please? Perhaps everybody else has already combined all their various PEPS and ISAs?

C_Mababejive

#8 Thanks bowlhead for a great explanation for what can be a confusing issue for many including me.
I think the thing is that there isnt always a clear view as to where your divi goes. If its paid out, you have it visible in your account..if its accumulated, well who knows where it goes?

Take for example a fund which i bought into in July in my ISA.

Kames high yield bond fund ACC units

ISIN GB0031425563

I invested £5000 and bought 2019 units at 248p

The platform website says

Tax cost £5045 what does that mean?
current value £4906
bid price 243.02p
units 2019.1415

The fund details a monthly divi

I dont have any clear visibility as to what my divi is per month and where it goes and the value of my investment appears to be going the wrong way..

dunstonh

I think the thing is that there isnt always a clear view as to where your divi goes.

That depends on the quality of your administration platform. The good ones will include distributions in their performance data by showing returns without and without distributions.

As for where they go, if you pay them to a cash account on platform then they will appear as a transaction on the statement. You also get the tax voucher at the end of the year so you can verify the info if you wish. If they are paid out to your bank account then they will appear on your bank statement.

dont have any clear visibility as to what my divi is per month and where it goes and the value of my investment appears to be going the wrong way..

You will have to wait until you get the tax voucher. Perhaps you should have bought the income units if you want greater clarity.

bowlhead99

If you followed my last post, well done It sounds like perhaps you didn't.

Basically the point of it was: you can choose to get the dividends paid out to you in cash, by selecting the Inc version; or you can choose to select the Acc version, where you agree to let the fund keep your dividends and go and spend them to buy more investments for you, so that the value of investments which the fund has attributable to your units will accumulate (be a bigger number).

If you took the Inc version, the fund has less assets attributable to each unit because it keeps sending you cash - the value per unit and therefore the price per unit is lower. You are right, you would see the cash visible in your own personal account, but at the same time, the investment units you have would be less valuable because they just sent you a bunch of cash rather than keeping it to reinvest.

As you have an ISA and presumably don't want to take money out of your ISA to spend in the outside world (because you lose the tax breaks and there is a maximum limit of how much you can stash inside an ISA each year), you would probably just re-invest the cash anyway, into that fund or another fund.

If you were just going to reinvest in that same fund it doesn't matter whether they give you the cash, reduce the assets per share and then you buy more units and they spend your newly subscribed units on new investments ; or whether they keep the cash and simply buy new investments on the dividend declaration date, cutting you out as a middleman. You end up at basically the same place, in terms of total value, whether you take the Inc version and reinvest, or just take the Acc version.

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So, assuming you understood these principles from my post #8 or Dunstonh's #7 or my new #15 right here...

When a fund 'accumulates' dividends each month or each quarter or each year in the ACC series, as an alternative to distributing the dividends in the INC series, it still keeps records because its investors still need to know what dividends they need to pay tax on, even if they don't choose to take them as cash. Even though the cash is auto-reinvested without passing through your hands, it represents income to you and it also increases the 'tax cost' of the units that you hold, just like if you had physically received it and reinvested manually. Normally at each dividend distribution point the fund will produce a distribution statement or tax voucher which will show the amount of dividend you were allocated.

As you're holding in an ISA, you don't really care about this tax info, and so you may have not looked on your platform for the tax vouchers (maybe they haven't been produced, maybe you'll simply get an annual statement instead). But you can see from the records they have kept for you, that your holding of the 2019 units that you bought is now showing a 'tax cost' of £5045, which implies to me that they've reinvested £45 worth of notional dividends on top of the £5000 you actually paid.

That sounds roughly right for a high yielding fund. Depending when you invested, you have probably 'earned' about two months of dividend (paid on 1 September, 1 October) and the £45 is about 0.9% of your £5000. If you extrapolate that out for a full year you get to 5.4% which is roughly in line with the 5.6% distribution yield shown on the latest Kames factsheet.

The fact that the total value of the fund, even after receiving income for a few months, is 'going the wrong way' (i.e. less than you first paid for it), is an entirely separate point. You don't expect market-related funds to move smoothly in one direction, they change all the time. So your 2019.1415 fund units were once worth 247.63p each (£5000) and now they are worth 243.02p (£4906). This is a bit over 98% of what you paid for them which is perfectly normal movement over a few months. Ideally you would have preferred them to have moved the other way, but that's life.

Obviously the assets held by your fund generate income - they are bonds or loans to companies all over the world. This is partially offset by management fees but the fund should still be making a cash profit on its income versus expenses. However, the capital value of the assets the fund owns (i.e. the bonds / loans) will change all the time.

The movement of the capital values of the loans can be attributable to changes in the companies' actual or perceived creditworthiness and general market sentiment, as well as the extent to which currency exchange rate movements are hedged.

Clearly if your fund pays £150 for a bond that yields £9 a year from a company (a 6% return on investment), but that company only has a BBB or CC credit rating, it might think it's a reasonable return for the extra risk over safer loans to governments or simply making a bank deposit.

However, if then everyone in the market starts talking about the US and UK government base rates maybe going up to 5%, nobody is going to pay anywhere near £150 for the bond that your fund bought. They could just put the money into a super safe bank deposit or government security and still get 5% a year which is almost as good a return as what the bond was yielding at a price of £150 for £9 a year.

They might consider paying £90 for the bond, because then the £9 a year income would be a 10% return and a decent premium over the risk free rate. So, when looking at its investment, your fund still owns the bond in the shaky risky company and still hopefully collects its £9 a year, but the market price of the bond is now only £90 compared to £150 yesterday.

So, you as an investor in the fund can be receiving dividends, and reinvesting them or not, but you can still easily lose money overall by investing into a bond fund when the market perceptions cause the bonds to become less valuable.

High yield bonds are risky which is why the returns they try to pay sound quite high. If interest rates rise, the bonds become less valuable. If the economy takes a downturn and the companies become less profitable, or stock markets start to wobble implying people have less faith in the companies, people may prefer safer loans with lower interest rates from more creditworthy companies or government - and the bonds become less valuable. So, that is why some people are willing to pay almost 1% a year in management fees for a high yield bond fund manager to work his magic. However if his strategy is to hold high yield bonds when bonds are becoming less valuable there is not much he can do to avoid paper losses (or actual losses) from time to time.

C_Mababejive

#15 Thanks once again for a lengthy but feature packed explanation. I shall read, absorb and try to learn. I'm sure it will be equally valuable to others also.

I always say that the only daft question is one that is never asked !

bowlhead99

There are no daft questions about investments, there are only daft people who don't think to ask questions about their investments and then at some point get annoyed because they made a loss or didn't make enough profit or paid too much fees or whatever. So, it's worth asking.

At least, that's the way I'd like to think of it. In reality, there are plenty of daft people who ask plenty of daft questions. They tend to get tolerated pretty well here though, takes all sorts to make an online forum!

jimjames

bowlhead99 wrote: »

There are no daft questions about investments, there are only daft people who don't think to ask questions about their investments and then at some point get annoyed because they made a loss or didn't make enough profit or paid too much fees or whatever. So, it's worth asking.

At least, that's the way I'd like to think of it. In reality, there are plenty of daft people who ask plenty of daft questions. They tend to get tolerated pretty well here though, takes all sorts to make an online forum!

The daft questions are the ones such as "I don't want to take any risk by investing in the stock market but I want to put all my money into carbon credits/land bank/shipping containers, is this ok?" But at least they are asking rather than just going ahead.

C_Mababejive

#15 The mention of tax statements....

Well my platform provider must be telepathic as one has just arrived in my in tray for me to study.

Details are

Bought the aforementioned fund 2019.1415 units for £5000 2.47629 per unit

There are three items named retention of income for (approx) £15/£16/£21 respectively and one called Accumulating equalisation at £8. Total =£61.78

It then quotes an estimated gross income of £266.27 giving an estimated yield of 5.43%

I guess im having difficulty in reconciling all this with the fact that the worth of my investment is still down.

bowlhead99

As you're not paying tax and don't need to do anything with the tax vouchers you're given, I wouldn't worry about it too much.

One of the items is 'equalisation' which just relates to the fact that you bought in part-way through a month so you're not really entitled to the full dividend amount like everyone else who held the fund for the whole month would be.

Say the fund is earning enough from its underlying investments to pay £15 or £16 income for the month. When you buy in, half way through the month, about £8 of the £15/£16 has already been earned. So effectively what you're buying when you fork over your £5000, is units at a price already reflecting some earned income. When they get around to paying the income, £8 of it hasn't been 'earned' by you, it's just the money you gave them being returned - so it's a return of cost and not an income.

In reality they didn't reach month end straight after you bought in, they kept going another fortnight and then would pay out the dividend at £15 or £16 or £21 or whatever the total income for the month is.

So, let's say your statement for the period to date is for three months. You paid them £5000. Due to you is £15 dividends for one month plus £16 dividends for another month plus £21 another month, totalling £53. However, there's a rogue £8 in there relating to equalisation. Really your income from the fund is only 45 not (15+61+21=53) (some roundings).

This £45 of net income together with equalisation proceeds gets reinvested for you and increases the capital value of the fund. If you were a taxpayer which you're not, you would care about your income level and your cost of investment for calculating your gains. Which was why on your first statement when it said the tax base cost of your units was £5045 (even though you only paid £5000 cash) I suggested they had conveniently increased the investment cost for tax purposes over and above the £5000 cash that you paid.

There was a related post about how equalisation and accumulation units work, ages ago (https://forums.moneysavingexpert.com/discussion/2370299) which might explain it even better.

Anyway ignoring all that, which I could try to explain a different way but it won't make it any more digestible and you shouldn't be worried about the tax intricacies when using an ISA anyway... the estimated gross income that they quote would be some kind of annualisation of the income received and expressed as a percentage of the amounts invested. As mentioned in a previous post, the estimated annual yield to an investor is 5 point something percent, which you can get from their monthly factsheet.

This headline yield ONLY relates to how much income is being made and distributed (or reinvested). It may be of interest to someone considering what types of investments it holds, and it may be of interest to someone who is considering getting the Inc version and taking the income out of the ISA to spend it, but it does NOT relate to how much the whole thing is actually 'worth'.

What mostly drives what the whole thing is worth, is the remaining value of the underlying investments, which can go up and down over a year quite significantly. I tried to explain this before but if you didn't follow, read on...

Finally:

I guess im having difficulty in reconciling all this with the fact that the worth of my investment is still down.

As mentioned in post #15... or at least I tried...

Your fund has assets (cash plus investments) which are worth X at the start of the year. The value of X will go up and down day by day as 'the market' determines what assets like those are worth.

Over the year, the fund gets income of Y. It incurs running costs of Z. At the end of the year the fund will be worth X + Y - Z.

You can choose to have Income Units where they pay you out the Y as they go along. In which case, at the end of the year, you'll have X-Z in the fund, and Y in your own bank account. Alternatively, if you 'reinvest' in those income units, you will have a total value of X+Y-Z in the fund.

Or, you can choose to have Accumulation Units where they never pay out the Y so you never need to manually reinvest it. At the end of the year, it will all be worth X+Y-Z. Basically the whole thing is worth the same whether you opt to keep taking the Y out and putting it back in, or you never take it out in the first place.

Now, remember that just a few paragraphs ago, we said "The value of X will go up and down day by day as 'the market' determines what assets like those are worth." ? Good.

So, if at the start of the year X is 100, and then at the end of the year X is 100 and Y is 6 and Z is 1, your whole thing (X+Y-Z) is worth 105. Your £5000 becomes £5,250

However, if at the end of the year, X is 80 and Y is 6 and Z is 1, then your whole thing (X+Y-Z) is only worth 85. Your £5000 becomes £4,250.

So, because X can fluctuate greatly, what you get back at the end is NOT just what you put in plus what income was received and reinvested. It is what you put in, plus what happened to the underlying investments held by the fund, plus what happened to the investments that were bought with the income that was generated and reinvested, less whatever management fees and running costs were incurred along the way.

So, once you understand that, you will not have too much difficulty understanding / reconciling in your head, the fact that you invested £5000 and your investments were bringing in some positive amount of cash, with the fact that the whole thing is perhaps now worth less than £5000. It is because the value of X can be any damn number that the market thinks it should be, from day to day.

If you go back to my example in #15. I suggested that a fund might have a high yield bond that it pays £150 for, and that delivers a £9 cash income every year (6% on what they paid). Then over time with market changes and lots of safer investments starting to pay bigger levels of income, that particular bond might decline in value to only £90, while still pumping out its £9 a year (10% on what it's now worth). It's an even higher yield for someone buying in at that point, but very disappointing for the existing holders.

In that situation, if your fund had spent all its money on the bonds at £150 each, the £5000 introduced into the fund by you would have acquired 33 bonds all paying £9 a year for about a £300 income on your £5000.

Then later, the bond price falls, and so the fund still holds 33 of them for you, but they are only worth £90 each instead of £150: your £5000 investment is now only worth £3000. The fund is still delivering that income of £9 per bond, £300 for all 33 of them, and the £300 income is now a 10% return on your current valuation of £3000.

That would be an example of how you could quite easily have invested £5000, be receiving and reinvesting a healthy £300 a year, but still have your whole fund value be worth a very great deal less than the £5000 it started off at.