S&S ISA, Funds and Providers

AimHigh

AnotherJoe wrote: »

Yes you are correct the tax treatment is irrelevant because its in an ISA.

I think bh made an error in his analysis. Minor but an error or should i say omission.


The income from the inc fund will spend some time "hanging around" before its reinvested.
In that time it will not earn any dividends/interest. The money thatw as automatically reinvested in the acc version, will do. Over a long enough time with a large enough amount, that would make a difference in favour of acc.

Someone mentioned using the money to rebalance but the idea with funds like this is, you buy them because they do the rebalancing for you.

That leaves paying for the ISA, which can be done by transferring in money as needed.

If you wish to have an income stream, then VLS is not classically the right fund to choose, you should choose one that is aimed at paying interest. The best way to get an income stream from VLS, IMHO, is by selling units. (which will come to the same thing as taking income, along the lines of bh's analysis, except your "income" is always fully invested until you need it.)

Good point but I think this is only relevant if you don't notice the income when it comes in and reinvest it straight away (whether in the same fund or different funds?).

AimHigh

bowlhead99 wrote: »

Heard my name...

There are a few reasons why a person might want to use Inc over Acc;

1) Tax tracking if investing outside an ISA or SIPP: receiving cash distributions means you are aware of taxable events such as receiving interest, dividends or other income. These might be taxable for you or might fit in your allowances but you'd still need to keep the records to prove that the income wasn't enough to be taxable. Also by manually investing the dividends received you can see how much you have added to your cost of investment when you use it to buy more units, which affects your capital gains calculations - again either because there may be tax to pay or because you need to keep the records. Whereas with Acc the reinvestment is done inside the fund behind the scenes and you may miss an event.

- But as others said, not relevant here

2) When you have a portfolio containing a number of funds it can be useful to use the dividends thrown off into your ISA cash account alongside your monthly contributions to reallocate cash to the other funds which are most in need (to keep your portfolio of several funds balanced in line with your target allocations).

- But in this case you are not juggling a portfolio of funds. With the amounts involved you will just have one mixed multi-asset fund. So any income generated that comes out into your cash pot within the ISA will just be destined to go right back into the same fund. So, using Inc units creates a hassle: in terms of the work involved to manually reinvest the money, the fact that you have an odd percent or two of your money 'out of the market' from time to time until you notice, and the costs of reinvesting if you're using a transaction fee-based platform. All to put the money right back where it came from.

3) If you are just 'buying and holding' with a lump sum investment and not planning to make ongoing contributions you will need money to pay the platform fees. So if you have five or ten funds you could set one or two of them to Inc mode and then the money arriving in the account from time to time will cover the ISA managers demand for fee money. Without that, i.e. if you were using Acc only, then in order to generate cash to pay fees you would need to do a few sales manually or just leave cash back dormant in the account from the time you first made the investment. And if you didn't address the issue, the ISA manager would need to sell some of your units to get cash for his fees - and might charge you for the hassle of doing that, if you are not already using a high fee platform where he does it for free.

- However in this case you are only using one fund so you can't set it for a fifth or a tenth of your dividends to be paid out and the rest accumulated. So if you go Inc then you will be generating several times more cash than you need for the 0.25%-0.45% (depending on provider) fees and will need to manually reinvest the excess income generated, so it is not a very neat solution. Also you are not just doing one fixed lump sum investment into a fund that you will then leave alone, you are adding money on an ongoing basis which should mean fees can be covered from this stream of deposits without needing to take income from the investment to do it.

4) An obvious reason to use Inc units is if you actually want to use the income generated for your day to day living costs or other opportunities (investment or otherwise).

- However in this case with your level of investing there will be no meaningful amount of income for quite some time. And over time you are going to be putting new money into the funds on an ongoing basis, moving money into tax wrappers (ISA, LISA, pension, whatever) within your annual allowances.

There is very little point moving £x into an ISA one month because you want to increase the amount of money you have invested and reduce the amount of money in your bank account... and reducing that year's precious ISA allowance by £x... buying a fund with it because you want an investment... then realising that £100 of dividends has arrived in the ISA and you don't want that to be put back into the investment... so you take it out of the ISA to get the £100 back in your hand.

You might as well have just put £x-100 into your ISA in the first place, and kept the cash in your hand. That way you have used up £100 less of your ISA allowance and have the right amount in your bank account for your ongoing spending needs.

There are probably more than just those 4 reasons why people would use Inc shares instead of Acc shares, but those 4 are to me the most immediately obvious ones and none of them are relevant to your situation. Acc is the easy option because for the moment your goal is to reinvest the income generated by the portfolio of companies held by the fund. So, just let the fund manager do the work and reinvest it without even trying to send it to you, rather than have him send it to you and then you do the work putting the money back into the fund after it sits around a few days or weeks or month until you notice it.

When you get older and have built up a significant amount of assets which are internally generating a decent amount of income, you can always switch to Inc units to take the cash out of the ISA to spend or invest elsewhere. Or, simply reduce the amount of new money you are putting into the ISA, leaving cash in your bank account to spend or invest elsewhere.

bowlhead99 wrote: »

Having a diversified set of investments working for you is how you create wealth. Some of them grow in value. Some of them send you income that you can use to reinvest in them or into something else. Some of them do both. What matters is the total return, which can be from income or growth or often a combination of the two.

I would recommend you don't get sidetracked by hearing anecdotes such as 'most of the returns of an investor in the FTSE over the last x years have come from dividends reinvested'. Each year, the companies generally make more and more profits whether you reinvest or not, as the world economy is growing. An investor in Google or Facebook or Apple or Amazon has had plenty of growth without having loads and loads of dividends.

Some of the big companies are very mature businesses that generate cash that they can't use and they will distribute quite a high proportion of those profits - if they don't need to hold on to the cash to grow their business, they give it back to their owners as dividends. Others reinvest the cash in new premises or assets - expand and grow or use it up investing in new products or new markets that make them more profitable in the longer term, and pay fewer dividends or perhaps none. But from your portfolio as a whole you will get a certain amount of dividends out of it.

Clearly if you take that money off the table and throw it in the bin or spend it on things in your day to day life, rather than sticking it back into investments, you will make much lower total returns. Because each pound of income you choose not to reinvest is a pound that could be invested in something that generates its own growth and its own dividends. But the growth is just as important as the dividends and some high growth opportunities may not pay dividends at all, and that's fine.

You don't need to necessarily take an 'income stream' from a company to become wealthier. The company has its own 'income stream' from its customers, and as you own a share of the company, you are getting wealthier each time they have a profitable month, whether or not the company distributes that income to you or does something else with it. If it doesn't distribute the cash it will generally be a more valuable business (because of the cash in its bank account or the results of spending that cash on profitable activities) and so people would pay you more to buy your share off you if you wanted to sell up.

So, it's great to have diversified income streams around the place but you don't need to physically receive the income to become wealthy. The income stream could just be earned by your company, or your fund that owns the company, and used up without ever reaching you.

You don't need to have the income coming in to your own hands to go off and do other investment opportunities; when some other opportunity comes on the horizon you could sell a bit of one of your investments to fund it, or fund it out of salary, and leave most of the investments untouched. If you pull money out of a fund by using Inc units and taking the dividends away, the money is no longer at work for you in that fund, so economically it is the same as if you had sold a bit of it. Either way, you have less money at work in that particular investment and more cash in your hand to buy a different investment.

Yet again, fantastic explanations/reasoning BH - many thanks for the advice. You've convinced me to go for acc units in the first instance. I guess another question that comes out of this is the fees aspect.

'Fees can be covered from this stream of deposits without needing to take income from the investment to do it.' - I am using HL as my provider, if I set up the fund to take a monthly deposit will this automatically deduct the previous months fees before investing into the fund? My understanding was that it would take charges from the cash in the account so is this not something I will need to manually keep topped up?

bowlhead99

AimHigh wrote: »

Good point but I think this is only relevant if you don't notice the income when it comes in and reinvest it straight away (whether in the same fund or different funds?).

Well, even if you do notice it straight away, it will still take a day or so to get it back in after you place the order to invest it. And you are not always going to notice it straight away because presumably you are not going to log in every day. Or you might get notified by email but not read your email that day. Or, you might know full well that the dividend will arrive on say 31 March, but you don't want to have to commit yourself to be available to log on that day and place an order to invest right away to keep the time out of the market to just a day or two.

Let's say you get a distribution from the fund into the account on Monday morning and that dividend is 2.5% of the value of your investment You notice the cash that afternoon and place an order to invest. That means your​ order will easily meet the "cut off" set by the fund manager for orders placed to subscribe in the fund for new units on Tuesday, which might be sometime Tuesday morning. On Tuesday evening about 9pm the US markets close and they use that to calculate the value and price for new units issued to investors on Tuesday​, including yourself.

So, your money was "out of the market" for all of Monday and all of Tuesday and is put back in the market at the fund valuation point at Tuesday market close. How far can a fund's value change in two days? Quite a bit, but let's say it moves 2.5% upwards. So you have basically taken 2% of your fund money, sat it on the sidelines a couple of days and then reinvested it at a higher price, basically missing 2.5% of value growth on that 2% of your money.

2.5% of 2% is 0.05% that you've lost by choosing Inc over Acc. So, instead of thinking your platform fee is 0.45% a year, your 'costs' are now 0.50% for the year. Some people will tell you that 0.45% is expensive anyway when you can find platforms charging 0.25%. So, 0.50% is even more expensive than that.

Some people (eg as dunstonh mentioned above) will use Inc for everything because of one of the advantages I mentioned, and not worry about it. Sure, you might lose 2.5% out of the market but you might gain 2.5% on another day because markets are pretty random and might fall instead. You would not expect to lose 2.5% each time.

For example, say a fund delivers on average 5% total return a year, sometimes much more and sometimes much less. There are about 250 business days a year. So on average being out of the market 2 days and coming back in at a higher price means missing 2/250ths of that 5% return. Not a lot. And that lost return is only on 2% of your portfolio value anyway because it was only the most recent dividends that were sitting in cash out of the market.

If you multiply it out, it is basically costing you less than a pound a year on a £100,000 portfolio. That's a perfectly reasonable price to pay for the advantages of Inc funds for the people who would actually benefit from Inc funds. But as we discussed in the previous post: at the moment with your one fund inside an ISA wanting to have all dividends reinvested, you are absolutely not a person who would benefit from it being an Inc fund.

So, it is not worth the costs and hassle even if the implicit costs are only under £1 per £100k in the long term (but sometimes £50 or more per £100k in any given year)

AimHigh

Understood - thanks. My mind is made up to go with an acc fund, it's just a case of getting my head around the charges given the fact it's reinvested before you see the money. Do you get the dividends and then they take their cut before reinvesting? If I set up a monthly contribution is it taken out of this before further shares are bought?

AlanP_2

AimHigh wrote: »

Understood - thanks. My mind is made up to go with an acc fund, it's just a case of getting my head around the charges given the fact it's reinvested before you see the money. Do you get the dividends and then they take their cut before reinvesting? If I set up a monthly contribution is it taken out of this before further shares are bought?

I am on Cavendish/Fidelity as a platform and the way they appear to do it is to calculate the Monthly Bill, take what they can from the small amount of dividends not currently invested (most of my Funds are ACC), and then sell a proportion of the largest value fund to make up the difference.

On some months my drip fed "buys" are at a higher price than my forced "sells" and some are the other way round - I view it as swings & roundabouts.

AnotherJoe

AimHigh wrote: »

Understood - thanks. My mind is made up to go with an acc fund, it's just a case of getting my head around the charges given the fact it's reinvested before you see the money. Do you get the dividends and then they take their cut before reinvesting? If I set up a monthly contribution is it taken out of this before further shares are bought?

If you mean charges by the fund, it doesn't work that way at all. Essentially, the price of the Acc shares just rises slightly faster than if you were paid the income. If its in an ISA there's nothing to track and nothing to take care of.

(unless you are happy to have a small amount of funds sold. Depends on your POV)

If you mean pay the ISA fees, you'll just need to put some cash in or otherwise make appropriate arrangements such as a linked bank account, to pay the ISA provider.

bowlhead99

With an acc fund the dividends never leave the fund to get to your platform.

Imagine you invest £1000 in an Acc fund at the start of a year. And are given 1000 units priced at a pound each. At the same time, you invest £1000 in an Inc fund also priced at a pound each.

Each fund takes this new £1000 of cash and invests it into its desired portfolio of companies. Over the course of the year the companies pay out 3% of their value as dividends which they send to the fund who owns equity in them. Also, over the course of the year the market thinks these companies are more and more valuable and at the end of the year they are valued 5% higher than at the start.

So in the two funds' records they are both holding £1050 of company value and £30 of cash from dividends, which is £1080. However, the fund manager is entitled to take 1% of average fund value as a management fee and the average value of the fund over the year was about £1040 so he is owed £10.40. So each fund only really has net assets of £1069.60 instead of £1080 and this includes companies worth £1050, so the cash that is spare for distribution to the funds' investors is only £19.60.

Basically with the net assets being worth 1069.60 and you having 1000 shares, the shares in both the Inc and Acc funds are worth £1.06960 per share. If you had the Inc shares, the next day they would pay you out their spare cash of £19.60 and be left with just £1050 of assets. They would pay that cash to your platform so you would have 1000 shares valued at £1050 (the price would fall to £1.05 per share) and £19.60 in your platform account as cash.

If you use the Acc fund instead of Inc fund,, they don't send you the £19.60 dividends. They just reinvest it into more portfolio companies and never pay you any piece of that "spare" cash, because it isn't spare - it was allocated to you inside the fund's bank account for tax purposes but then formally used up for new investments. They don't give you any money so you don't need to spend that money buying any new shares. You still have the 1000 shares representing £1069.60 of assets, so the shares in the Acc fund are still worth £1.06960 each. Whereas the shares in the Inc fund are only worth £1.05 each but you have some cash in your platform account too.

In your case you would probably spend the £19.60 you got from the Inc shares on re-investment, buying more Inc shares at £1.05 each. Buying between 18 and 19 shares. At the end of the reinvestment process you will have £1069.60 of fund assets in an Inc fund, compared to the other option of having £1069.60 of fund assets in an Acc fund. The only practical difference is the displayed price and quantity of shares you own, but investment exposure is the same in both cases, its just that one involves the fund sending money temporarily to your platform before you put it back, and the other didn't bother.

So basically you get the benefit of all the dividends in both cases, and the fund manager has taken his management fee in each case. But only with Inc do you actually own more shares at the end of the process.

If there are other fees you owe to the fund platform (e.g 50p to platform admin fees) you generally have the choice to pay them from money in the ISA account, add more money to the account to make sure there's​ enough, perhaps pay them from a linked account with the same ISA manager, or pay them out of the dividend income that arrived in your ISA account before re-investing the leftovers (which only works with Inc units because Acc units don't ever have that cash arriving in the ISA cash account).

So generally with Acc shares if you didn't leave some cash left over in your ISA account in the first place, you would have to sell some shares (which maybe the ISA platform would do for you automatically) or use some of your ongoing contributions. In the latter case, many platforms (but not all) allow you to set the ongoing investment level a little lower than ongoing cash direct debit funding level from your bank, to deliberately leave a bit spare.

Audaxer

bowlhead99 wrote: »

With an acc fund the dividends never leave the fund to get to your platform.

Imagine you invest £1000 in an Acc fund at the start of a year. And are given 1000 units priced at a pound each. At the same time, you invest £1000 in an Inc fund also priced at a pound each.

Each fund takes this new £1000 of cash and invests it into its desired portfolio of companies. Over the course of the year the companies pay out 3% of their value as dividends which they send to the fund who owns equity in them. Also, over the course of the year the market thinks these companies are more and more valuable and at the end of the year they are valued 5% higher than at the start.

So in the two funds' records they are both holding £1050 of company value and £30 of cash from dividends, which is £1080. However, the fund manager is entitled to take 1% of average fund value as a management fee and the average value of the fund over the year was about £1040 so he is owed £10.40. So each fund only really has net assets of £1069.60 instead of £1080 and this includes companies worth £1050, so the cash that is spare for distribution to the funds' investors is only £19.60.

Basically with the net assets being worth 1069.60 and you having 1000 shares, the shares in both the Inc and Acc funds are worth £1.06960 per share. If you had the Inc shares, the next day they would pay you out their spare cash of £19.60 and be left with just £1050 of assets. They would pay that cash to your platform so you would have 1000 shares valued at £1050 (the price would fall to £1.05 per share) and £19.60 in your platform account as cash.

If you use the Acc fund instead of Inc fund,, they don't send you the £19.60 dividends. They just reinvest it into more portfolio companies and never pay you any piece of that "spare" cash, because it isn't spare - it was allocated to you inside the fund's bank account for tax purposes but then formally used up for new investments. They don't give you any money so you don't need to spend that money buying any new shares. You still have the 1000 shares representing £1069.60 of assets, so the shares in the Acc fund are still worth £1.06960 each. Whereas the shares in the Inc fund are only worth £1.05 each but you have some cash in your platform account too.

In your case you would probably spend the £19.60 you got from the Inc shares on re-investment, buying more Inc shares at £1.05 each. Buying between 18 and 19 shares. At the end of the reinvestment process you will have £1069.60 of fund assets in an Inc fund, compared to the other option of having £1069.60 of fund assets in an Acc fund. The only practical difference is the displayed price and quantity of shares you own, but investment exposure is the same in both cases, its just that one involves the fund sending money temporarily to your platform before you put it back, and the other didn't bother.

So basically you get the benefit of all the dividends in both cases, and the fund manager has taken his management fee in each case. But only with Inc do you actually own more shares at the end of the process.

Great detailed explanation bowlhead. Taking that example, with the Acc fund would your online account have a separate entry showing the dividend amount of £19.60 added to your holding?

badger09

Audaxer wrote: »

Great detailed explanation bowlhead. Taking that example, with the Acc fund would your online account have a separate entry showing the dividend amount of £19.60 added to your holding?

NO!

I've tried to highlight the appropriate bits from bowlhead99's post

bowlhead99 wrote: »

With an acc fund the dividends never leave the fund to get to your platform.


If you had the Inc shares, the next day they would pay you out their spare cash of £19.60 and be left with just £1050 of assets. They would pay that cash to your platform so you would have 1000 shares valued at £1050 (the price would fall to £1.05 per share) and £19.60 in your platform account as cash.


If you use the Acc fund instead of Inc fund,, they don't send you the £19.60 dividends. They just reinvest it into more portfolio companies and never pay you any piece of that "spare" cash, because it isn't spare - it was allocated to you inside the fund's bank account for tax purposes but then formally used up for new investments. They don't give you any money so you don't need to spend that money buying any new shares. You still have the 1000 shares representing £1069.60 of assets, so the shares in the Acc fund are still worth £1.06960 each. Whereas the shares in the Inc fund are only worth £1.05 each but you have some cash in your platform account too.

bowlhead99

As Badger says, with "Acc" the £19.60 does not get "added to your holding" in your online account in any visible way. The £19.60 is the simply the residue of £30 of income earned from portfolio companies *inside the fund* less £10.40 of fund management fee and other fund running costs deducted *inside the fund*. None of that is happening visibly in your online account with the investment ISA platform.

What you see on your ISA investment platform is simply that the 1000 shares in the fund that you bought for £1 each are now worth £1.06960 each or £1069.60 in total. Your fund value has gone up in value by 6.96% over what you initially put in, from £1000 to £1069.60. £19.60 of that £69.60 value growth happens to be due to "dividends sent to the fund by portfolio companies less running costs of the fund", and the other £50 of that is due to "the portfolio companies owned by the fund becoming generally more valuable over the course of the year".

If you choose the Inc fund, the fund will send £19.60 to your ISA platform and then the remaining fund value will only be £1050 because all it has is £1050-worth of investee companies and zero cash because it sent all the spare cash to your ISA. But if you choose the Acc fund, it will not send £19.60 of cash to your ISA - it will hang onto that money and buy another £19.60-worth of investee companies. So it will still be worth £1069.60.

By choosing to invest in the Acc fund you are explicitly saying to the fund manager that you *do not* want him to distribute any money to your ISA platform account- because all you would want to do with it if you received that £19.60 cash in your ISA is request that it is invested back into the fund it just came out of.

So, by saying "don't send me any money, I don't want it", you are asking them to keep the £1069.60 of fund value and just reinvest the money they got from the underlying portfolio companies, to make more investments into portfolio companies. It does not matter to you how much of the increase in value was to do with income and how much was to do with the companies becoming more valuable, because you've said you don't want the income in cash anyway because you've got no use for it at the moment.

In an ISA there are no tax considerations because you don't pay income tax or capital gains tax so you don't need to calculate separately the income bit and the gain or loss bit. If you wanted to go and read the fund's annual report or factsheet you could look back and work out what had happened but in an Acc fund this is all happening behind the scenes and the different components of overall value generation are not something that you see moving through your online ISA, because you explicitly wanted it to happen behind the scenes and automatically so you didn't have to get involved with receiving cash and reinvesting it into the fund.

As you are not manually reinvesting any money yourself (not putting anything more into the fund) in an Acc scenario, the quantity of fund shares you own does not increase. However, each Acc share is more valuable than it would have been if it had been an Inc share that kept throwing cash back out of the fund and into the investors hands, which is an action that reduces the value of each Inc share every time they do it.