How does compound interest work on accumulation funds?

As I understand it, compound interest is interest earned on the interest that is reinvested. But with accumulation funds, the dividends don't buy more units in the fund itself. So how does compounding work on accumulation funds if the amount of units stay the same?
I'm relatively new to investing so apologies if this has been covered before. 

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  • MX5huggyMX5huggy Forumite
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    The value of the units goes up, because the fund buys more of the stocks held by the fund, or holds the dividends as cash within the fund. 
  • edited 16 January at 12:36PM
    ThrugelmirThrugelmir Forumite
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    edited 16 January at 12:36PM
    Cash and capital gains the funds received is reinvested into further investments. 
  • AmazinAmazin Forumite
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    Correct me if I'm wrong, so profits from investment will be reinvested if it's enough to buy more units. If not then it will be held as "cash" until enough to buy more units? 
  • edited 16 January at 12:55PM
    wmb194wmb194 Forumite
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    edited 16 January at 12:55PM
    Amazin said:
    Correct me if I'm wrong, so profits from investment will be reinvested if it's enough to buy more units. If not then it will be held as "cash" until enough to buy more units? 
    No, they don't buy more units in themselves, they buy more of the assets - shares, bonds, etc. - that the fund was established to invest in.
  • dunstonhdunstonh Forumite
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    But with accumulation funds, the dividends don't buy more units in the fund itself. So how does compounding work on accumulation funds if the amount of units stay the same?
    If you reinvest the income into INC units you buy more units but the unit price is lower as the income has left the fund.
    With ACC units, the income never leaves the funds and is reinvested into the assets within the fund.

    So, the INC unit price will always be lower than the ACC unit price.  If you held the same amount in INC units and ACC units you would have a different unit price and a different unit count but they would equal the same value. e.g. 5x4 and 4x5

    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • edited 16 January at 1:19PM
    ColdIronColdIron Forumite
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    edited 16 January at 1:19PM
    Amazin said:
    Correct me if I'm wrong, so profits from investment will be reinvested if it's enough to buy more units. If not then it will be held as "cash" until enough to buy more units? 
    The fund does not buy units, you do. The fund creates and destroys units (which are just accounting entities)
    When money flows into the fund from investors the fund managers buy more of the underlying holdings, create units (and fractions of units) and allocate them to the investors
    When investors want to redeem their units the fund managers sell some of the underlying holdings, destroy some units (and fractions of units) and pay the cash to the investors
    The dividends from the underlying holdings merely increase the value of the existing units

  • jimjamesjimjames Forumite
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    As I understand it, compound interest is interest earned on the interest that is reinvested. But with accumulation funds, the dividends don't buy more units in the fund itself. So how does compounding work on accumulation funds if the amount of units stay the same?
    I'm relatively new to investing so apologies if this has been covered before. 
    Compounding is the growth over multiple years. So if the fund grows by 5% one year, 10% the next and 2% the year after then all of those are compounded. You don't need interest or more units for compounding to be effective.
    Remember the saying: if it looks too good to be true it almost certainly is.
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