'Acc' funds vs 'Inc funds with dividends reinvested'

Ashen

Hi,

I'm looking to choose between Acc and Inc for a fund-type, but note that I get the option to choose what happens with any dividends. I get that Acc avoids any temptation to spend, but I'm not sure what other advantages there might be, as with Inc I could always change the option for reinvesting dividends or not?

I see on this article on Monevator that it states "Reinvesting dividends in Vanguard accumulation class funds definitely is cheaper though" but I'm not sure exactly why.

http://monevator.com/income-units-versus-accumulation-units-difference/

Thanks for any help - hopefully I haven't made some glaring error!

Superscrooge

If you are looking at re-investing the dividends I would buy Acc as there are sometimes extra charges for reinvesting dividends from Inc funds. So Acc is often the cheaper option and it all happens automatically.

Further info on the below link

http://www.morningstar.co.uk/uk/news/69927/share-classes-accumulation-vs-income.aspx

bigadaj

If you're holding these for the long term then accumulation is a lot easier, unless you're looking to reinvest dividends elsewhere which is a little against the idea of a long term investment which I assume the vanguard fund is intended to be.

If within an Isa or pension the I would say always do accumulation, if unwrapped then you have issues with income tax on dividends and potential future capital gains tax liability that would make income units more attractive in terms of record keeping.

If you indicate how much and in what wrapper you're investing this should become clearer.

george4064

There are various pros and cons, and a few depend on your situation.

Pro acc;

- Any dividends are reinvested at source by the fund manager, meaning that it gets reinvested much faster than if you had to reinvest the fund dividend yourself back into the fund. It could also save you on dealing costs if applicable, and potentially on income tax liability (again if applicable).

Cons acc;

- Not a major con in my opinion, but if you bought acc units and you decided at some point you wanted to take income. You would have to switch out of the acc units and into the inc units, this would give you one day out of market exposure.

- Now, this is just my theory and has not been proven right (nor wrong though); by buying the Acc units your and missing out on the positive effectives of compounding dividends. With Acc units, you see the benefit of income through the price of the Acc units increasing (this is why you see Acc unit price higher than the Inc unit price). Whereas with the Inc units, you will be able to use the income to buy more units (remember you will have to wait for the dividend payment date) thus creating a compounding effect.


Just a note on the 2nd con, Id love for this to be put to the test. Maybe someone already has? I just get an inkling that over the long run Inc units reinvesting (and compounding) would beat Acc.

Linton

george4064 wrote: »

.......
- Now, this is just my theory and has not been proven right (nor wrong though); by buying the Acc units your and missing out on the positive effectives of compounding dividends. With Acc units, you see the benefit of income through the price of the Acc units increasing (this is why you see Acc unit price higher than the Inc unit price). Whereas with the Inc units, you will be able to use the income to buy more units (remember you will have to wait for the dividend payment date) thus creating a compounding effect.


Just a note on the 2nd con, Id love for this to be put to the test. Maybe someone already has? I just get an inkling that over the long run Inc units reinvesting (and compounding) would beat Acc.

Doesnt sound right to me. Whether you reinvest inc dividends or the dividends are immediately included in the underlying fund shouldnt make any difference In both cases the same total %allocation of underlying shares is growing at the same rate. With the marginal difference from con 1.

Ashen

Thanks for the replies. I gather then that Acc has enough benefits that if I'm not likely to want to take out dividends for quite a while I should go for that, and it shouldn't be too much effort to change to Inc if it becomes more appropriate at a later stage.

What I'm looking to do really is put in most of my ISA allowance this year to likely Vanguard LS 60, with the possibility of moving in some of a 2 year cash ISA of about £35,000 (due to 'mature' in about half a years time), along with possible contributions during the year if possible.

Superscrooge

If it was me I would opt for accumulation units.

As explained in your initial link to the monevator site;

The advantage of accumulation units is that the devil-in-you has no chance to make mischief. The income is rolled up into the runaway snowball of future wealth, and you’ll barely even miss it.

In contrast, reinvest yourself and – aside from the potential self-sabotage already mentioned – you may lose a slice of your income to trading costs:

Initial charges
Brokerage reinvestment charges
The bid-offer spread

Accumulation units side-step all that.



.

bowlhead99

george4064 wrote: »

Cons acc;

- Not a major con in my opinion, but if you bought acc units and you decided at some point you wanted to take income. You would have to switch out of the acc units and into the inc units, this would give you one day out of market exposure.

If you want to get access to the 'income' out of your Acc fund to spend or reinvest somewhere else then yes, of course, you could sell completely out of the Acc fund, be out of the market for a day(unless your platform allows same-day switching), buy into the Inc fund and wait for the income distribution date to come around. But just as easily, you could simply sell out enough units of the acc fund to get you the cash you want.

Example, at the start of the year you have 100 units of Acc fund valued at £100 each, total £10000. Over the year they each generate £5 of income and become worth £105 each (£10,500 total). If you had the Inc fund they would send you the £5 per share (£500) and the remaining shares would again be worth £100 each (£10,000). With the Acc fund they will keep the £5 to reinvest it internally and the units stay at £105 each (£10,500) in the fund and £0 in your hand.

If you want to start taking money out of the fund then of course you could sell your Acc units and buy Inc units and wait for them to send you the £500 of cash. But just as easily you could just sell 4.76 of your £105 ACC units, and get hold of the £500 of cash, keeping hold of the other 95.24 units worth £10,000. Many platforms don't have transaction charges for selling units. You would be in the exact same position (£10000 of fund value and £500 in your hand) as if you had been in the Inc fund and taken the cash dividend.

Similarly if you were in the Inc fund but didn't really want the £500 cash they sent you, you would just use it to buy 5 more £100 income units; many platforms don't have transaction charges for buying units. So you could choose to just have 105 Inc units at £100 worth £10500 and zero cash in hand, which is the same financial position as having 100 Acc units worth £10500 and zero cash in hand.

So, either fund can produce whichever financial result you want. If you only want to take £400 out of the fund annually then you have a choice of taking £500 dividends from the Inc version and reinvesting £100 of them, or just using the Acc version and selling £400 of units each year. If you wanted £600 out of the fund annually you would have a choice of taking £500 dividends from the Inc version and selling a further £100 of units, or just using the Acc version and selling £600 of units. You get to the same place.

The only difference is charges, where depending on your platform you may be charged a material amount for either manually reinvesting or for selling units. There are a whole range of charging structures available when you're platform shopping. As the monevator article hints, from a financial savvy-ness point of view it is really just the charges (transaction fees and bid-offer spread) which would lead you to favour Acc or Inc funds depending whether or not you actually want the natural level of income which gets distributed in the Inc funds.

- Now, this is just my theory and has not been proven right (nor wrong though); by buying the Acc units your and missing out on the positive effectives of compounding dividends. With Acc units, you see the benefit of income through the price of the Acc units increasing (this is why you see Acc unit price higher than the Inc unit price). Whereas with the Inc units, you will be able to use the income to buy more units (remember you will have to wait for the dividend payment date) thus creating a compounding effect.

Just a note on the 2nd con, Id love for this to be put to the test. Maybe someone already has? I just get an inkling that over the long run Inc units reinvesting (and compounding) would beat Acc.

Linton politely says "doesn't sound right to me". The less polite way of saying it is, it's hogwash.

Follow my earlier example. You think that taking the £500 dividends out of the INC fund via dividends, and then putting it back in by buying more units to give you £10500 of funds again and £0 in your hand because you want the £10500 to compound up to a bigger number over time... is going to magically give you a better return over the long term then just letting the £10500 stay in the fund in the first place with the ACC option?

With Inc fund reinvestment you will end up with 105 units at £100. With Acc fund you will end up with 100 units at £105. Either of those options means the fund manager is holding £10500 of investments in your name and if he generates 5% income over the next year you will make another £525 no matter whether it is paid out or rolled up.

You said yourself:

Pro acc;

- Any dividends are reinvested at source by the fund manager, meaning that it gets reinvested much faster than if you had to reinvest the fund dividend yourself back into the fund

So, if you agree with that, it seems bizarre that you would say that a negative point about acc funds is that you are going to miss out on compounding compared to if you had used an inc fund, taken the money out and then reinvested it yourself back into the fund. How can you be 'missing out' by letting the manager reinvest it without going through the rigmarole of cutting you a cheque that you then send back to him?

All other things being equal, reinvesting internally by the manager is not going to be a slower or more inefficient process than you waiting for a dividend cheque and giving it back to the manager so he can reinvest it for you.

Id love for this to be put to the test. Maybe someone already has?

See above, QED.

Pro acc;

It could also save you on dealing costs if applicable, and potentially on income tax liability (again if applicable).

It saves on dealing costs (platform dependent) if you are happy to let your investment accumulate up and don't want to take the money out to use in your day-to-day life or to rebalance your portfolio by reinvesting into other funds. It adds dealing costs if you did want to do those things because you have to manually sell to get your hands on the money.

Letting the income roll up inside an accumulation fund does NOT save you on income tax liability. If you invest in a fund that generates income, whether it physically distributes to you or just internally distributes to itself and reinvests, you need to declare and pay tax on the income. The tax liability is the same for an Inc or Acc fund because both involve the fund manager going out and making dividends for you. The fact that in one situation they are retained by the fund manager to reinvest for you for your administrative convenience, does not mean you don't owe taxes.

Of course taxes are a moot point for some because they are investing in ISAs or SIPPs or because they are not earning enough to pay income taxes on their dividend income (i.e. not high rate taxpayer for 2014/15, or not earning more than £5000 divs for 2016/17). Still, it is definitely wrong to tout reduced tax liability as a reason to go for an Acc fund.

You get the same tax liabilities with either fund type, and in fact as bigadaj suggests, taxpayers may prefer Inc funds because you might find it easier to track your tax liabilities if you are physically receiving dividends and are easily able to see your cost of reinvestments from the itemised transactions on your bank statements or fund platform statements. Rather than the reinvestment be some notional concept within the fund that has to be extracted from a whole load of tax vouchers at some point down the line.

george4064

@bowlhead99

I did not know about the tax implications of acc units, interesting to know. Everyday's a school day!

Regarding my theory (yes its just a theory, and I have never tested it or anything). I understand your points, but without definite proof via a test I will always be sceptical. With reinvesting using inc units, you actually create a compounding effect, whereas with Acc units it just affects the unit price which in effect benefits everyone else and thus not compounding.

I'd rather not drag my theory discussion on much, it isn't going anywhere, I have not and will not act upon my theory.

bowlhead99

george4064 wrote: »

Regarding my theory (yes its just a theory, and I have never tested it or anything). I understand your points, but without definite proof via a test I will always be sceptical.

You could always run some imaginary numbers, as I did, to prove that taking money out of the fund in the form of a dividend and then investing it right back into the fund cannot give you a better return than leaving the money in the fund in the first place.

Pick a rate of return on the assets that the manager chooses to buy, and a number of shares in the fund, and a number of shares that you personally choose to buy, and see that the return from an inc fund with divs paid out and then reinvested, is not any better than the return from an acc fund with the divs never paid out so they don't need to be reinvested.

If that's not the case - then where do you imagine you would somehow be able to make your extra 'compounding' returns from, if you temporarily take the cash out and then reinvest it ASAP, instead of just leaving it there? What happens to the money - simply by the action of you taking it out and you putting it back in - that would make it be somehow able to grow faster than if it stayed in the fund without bothering to take the round trip to your bank?

As I pointed out, you said yourself in your first post that an advantage of an ACC fund was that the money was reinvested right away, without needing to pay it out to you and have you reinvest it. So this has to be the optimum way to invest if you don't want to take the money out to spend.

The only way the investment manager can give you your dividend cash in your own hand, is by sending it to you and reducing the amount that's retained in the fund in your name, by the same amount. So if there is £10500 of fund assets in your name at the end of the year (100 shares each representing £105 of asset value), and the manager pays out its spare cash as a £5 per share dividend, your 100 shares are not going to be worth £105 each any more, they will only be worth £100 each. Because £5 of cash per share that was sitting in the fund's bank account and making up part of the £105 value, no longer exists - it was paid out into its investors' own hands.

As a consequence, the fund assets held in your name, represented by your 100 shares, are worth £10,000 and separately you have £500 of cash in your hand; because each of your 100 shares paid a fiver.

In order to 'compound' your returns, you have to ensure that the £500 is not spent by you or sat in your bank account for the next year, but reinvested in the fund. So, if you are in the Inc class, you will need to manually reinvest that £500 by asking the manager to issue you with 5 new shares at their fair value of £100 each. So that the manager once again holds £10500 of assets for you. The £10,000 of investments and the £500 of cash you just gave him. With the £500 of cash you just gave him, he can go out and buy more investments so that he holds £10500 of investments instead of £10,000 of investments. Your £10500 of investments spread out equally over your 105 shares, represents a fair value of £100 per share.

By contrast in the Acc fund, the manager doesn't bother to send you your share of the cash he generated (the £500). He just reinvests your £500 cash right away, into more investments, so that he holds £10500 investments instead of £10000 investments and £500 cash. You still hold 100 shares and each of those shares are 'worth' £105 each.

IN BOTH CASES - "Acc fund" or "Inc fund with divs reinvested" you will have £10500 of investments going into the second year. The 'reinvesting the income you took out' can't possibly give a stronger return than simply 'investing the income and not bothering to take it out'. With both of them, you will be going into the first day of a new year with the fund manager looking after £10500 for you. As you can imagine, if the fund manager invests this £10,500 into the same mix of assets in the two funds, you will get the same return for the next year.

Over the next year, if he makes another 5% return from the dividends paid out by the companies he's investing into, he will turn your £10500 of investments into £10500 of investments plus £525 of cash, together valued at £11025. Whichever version of the fund you are in, your £10500 of value at the start of year 2 will grow by the same amount to the same new amount of total value at the end of year 2, £11,025.

In the Acc fund, your original 100 shares are valued at £110.25 each for the £11025 total (which we have said is represented by £10500 of investments and £525 of cash). In the Inc fund, you had 105 shares, so these will be valued at £105 each for the £11,025 total.

With the Inc fund at the end of year 2, he will pay you out the income that arrived that year. You will get £525 cash in your hand. The Inc fund no longer has any spare cash because it paid it to its investors. Instead of £10500 of investments and £525 of cash, your fund value is now just the £10500 of investments, because the £525 is in your own hand. The value per share of the Inc units will have to drop. £10500 of investments spread over your 105 shares, is £100 per share again.

As you have recognised, if you want to 'compound' your returns from the Inc fund and build them up during year 3, you will need to manually reinvest that £525 of cash. The units of the Inc fund are all valued at £100 each so your £525 will allow you to buy 5.25 units. The fund manager will use your £525 to buy investments so that instead of £10500 plus your £525 cash subscription, he will be holding £11,025 of investments for you. At this point, you will be holding 100 shares bought at the start, 5 shares bought at the end of year 1, and 5.25 shares bought at the end of year 2. Total of 110.25 shares which we know are valued at £100 each, making up your £11025 of value.

By contrast at the end of year 2 with the Acc fund, the fund manager had your £10,500 of investments and £525 of cash but DIDN'T need to pay you the £525 of cash. He just buys more investments for you with it. So you get £11025 of investments, without any messing about.

With the Acc fund you have never subscribed for any more units because you never had the spare cash in your own hand. So you still have 100 units, and they now represent £11025 of assets, the value per share is £110.25

So going into year 3, you have the choice of

- having gone the ACC route and hold 100 shares worth £110.25 each for £11025 total value, or

- having gone the INC route and reinvested your income to buy new shares each year end, now holding 110.25 shares worth £100 each for £11025 total value.

In both situations you enter year 3 with the fund manager holding £11025 of investments for you. You could make this a very long post by repeating the explanation for year 4, year 5 etc etc etc but you are never going to magically make the returns from the INC fund somehow leapfrog the returns from the ACC fund.

With reinvesting using inc units, you actually create a compounding effect

By re-investing your dividend income in an Inc fund you are getting a compound return which is better than the return you'd have got by taking your dividend money off the table and spending it. But this is not a better return than the Acc fund which never even let you have the temptation of taking your dividend money off the table and spending it.

All you are doing is putting the money from your Inc fund back into the Inc fund so that it can grow like the Acc fund money is going to grow.

I'd rather not drag my theory discussion on much, it isn't going anywhere, I have not and will not act upon my theory.

In that case you probably didn't want to see me type all that to try to explain it a second time

But there's no point going through life forever having a niggle in the back of your mind that you have discovered a special clever way to invest. Even though you don't plan to use it at the moment, at some point in the future you might go with your instinct to follow this gut instinct and turn down some slightly better opportunity in favour of it.

The other smart people in the investment community (with whom you're competing for investment opportunities whether you realise it or not) have already considered this premise briefly, and realised it to be false.

dark.knight_3

Great post bowlhead. A quick question though, the following funds are the same thing just 1 is inc and the other acc. If reinvesting the dividends in the acc version gives greater compounding why are the performance graphs on the below links both the same? I would assume (don't know for certain) that they initially started off at the same value when the fund began and yet 5 years later the return on your initial investment is at the same percentage. With reinvesting the divi surely the acc has grown at a larger rate than the income?

http://www.iii.co.uk/investing/factsheet/FPC8/vanguard-ftse-uk-equity-income-index-inc

http://www.iii.co.uk/investing/factsheet/FPC7/vanguard-ftse-uk-equity-income-index-acc

e.g if the fund started off at 1,000,000 with 10,000 units split between inc and acc at £100 each and had grown with the stock market in 5 years to 161.00 for the inc and 214.00 for the acc surely the return on your £100 would be different?


Or am I missing something obvious?