New to funds, got some questions

bowlhead99

Rawhy wrote: »

So by that, do you mean once I sell my acc. funds, I only use, say, 50% of the money to buy income and keep the other 50% to use? Sorry, I'm a bit confused by "by a combination of taking income and selling units".

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Oh, now I think you mean to buy both acc. and income funds, but to swap one for the other over time. Is that what you mean by "selling unist". Hmmm, are the stocks in the two funds different? Otherwise I don't know what you mean by:
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Both the income and acc. version of the fund is following the same index, how can they be different?

Really Joe's post is mixing a couple of different concepts without really explaining how he got to the other concept.

You are right that Inc and Acc units of the same fund will have the same underlying assets and changing from one to the other won't change your risk exposure. Inc just means you are pulling money out of the portfolio from time to time and with Acc you are simply letting the natural level of dividend be reinvested in the portfolio and keep running.

However, what Joe is getting at is that once you stop building up your portfolio and want to start taking money from it instead (e.g. in retirement), you will probably have some target level of cash in mind. For example, perhaps once you have an investment pot of £500k, you will want to take out £20-£25k per year.

The problem many people have when they come to get there, is that the natural level of dividends on a balanced portfolio is quite possibly not going to produce as much cash in their hands as they actually want to take. For example, £20-25k on £500k is 4-5%, and a mixed portfolio that contains a decent proportion of worldwide equities and bonds does not really generate natural income of 4%+ at the moment.

The only way to get to the 4% is to either

- pick an index that has a particularly high level of dividends because it's concentrated in specific industries and company types -eg. UK FTSE100 has a high bias to oil and gas, big pharma and banks/financials ; but would be a poor choice for your entire portfolio as it's missing some industry types entirely and all the companies listed on other world stock markets.

-or to use a specialist fund which is deliberately focused on generating a high level of income by (for example) favouring dividend payers over growth stocks or certain types of bonds over other types of bonds and equities etc

Neither of those are ideal (in terms of having a broadly diversified portfolio that ties in to the level of risk and volatility you're looking to take with your investment holdings).

So what happens is, people will build a normal balanced portfolio containing a diversified mix of growth stocks, income stocks, bonds and real estate etc, and acknowledge that it would be a freak of coincidence if it happened to generate the exact amount of natural income they wanted to take in a specific year. So, they will pretty much inevitably be buying or selling units to make up the difference between what the income units of their funds pay out, and what cash they want to see in their bank account that year and what should stay in their portfolio.

Once you realise you will still need to be buying or selling units anyway, there is no longer a particular rush to flip all your Acc units into Inc units in retirement.

As a practical point, people might have a preference for Inc units over Acc units if they are holding their investments outside tax wrappers and want to more easily see the cash flows to prompt them to track the income and base costs accurately for tax record keeping; or if they have lots of funds that need periodic rebalancing across them, it can be handy to use Inc units to have income coming in to mix with your new money each year - may allow you to be able to afford the rebalances without selling anything.