If you’re interested in investing in exchange-traded funds (ETFs), one decision you’ll need to make is whether you want to invest in an accumulating or distributing fund.
Continue reading my guide to discover the differences between accumulating vs distributing ETF to help you find the right fund for your investment goals.
Also consider: My guide on the Best ETFs to Buy Now UK
- The main difference between distributing and accumulating ETFs is that a distributing ETFs pay out dividends to investors, whereas accumulating ETFs reinvest dividends and interest into more fund units.
- Distributing funds tend to be more suitable for investors seeking a steady, regular income on their money.
- Meanwhile, accumulating funds tend to be preferable for investors seeking to generate returns over the long term.
What is an accumulating ETF?
An accumulating ETF reinvests dividend income gains or interest generated into more assets. This means that if the ETF holds shares which pay dividends or interest-paying assets such as bonds, loans, or even cash, these proceeds will be automatically reinvested into more assets.
The major benefit of the fund reinvesting dividends and interest income rather than paying it out to you as the investor is that you’ll automatically benefit from compound returns – essentially growth on growth – without a) missing out on any returns while you carried out this process, or b) paying a commission charge to make another investment.
Consider this example. A fund has a net value (NV) of £100,000 with 10,000 shares issued. This makes the net asset value (NAV) £10 a share – that’s £100,000/ £10,000. You have 100 ETF shares (also known as “units”), worth £1,000.
The fund contains 1,000 shares in a company that I’ll call the Dividend Co, with each one worth £10.
The Dividend Co then decides to pay a dividend of £2 a share, meaning the fund receives £2,000 in dividends – that’s £2 for each of the fund’s 1,000 shares. As this is an accumulating ETF, that gives the fund £2,000 more in cash, taking the NV to £102,000. In turn, that makes the NAV £10.20.
As you have 100 ETF units, that means your holdings are now worth £1,020 with the reinvested dividends. This value has been automatically reinvested into more assets by the fund, increasing the value of your units rather than paying it out to you.
Of course, the value you can generate from the ETF will depend on how many units you hold – the more units you have, the greater your returns will be from the reinvested dividends and interest payments.
Interestingly, these funds essentially only exist in Europe. That’s because a US-domiciled mutual fund is required to distribute at least 90% of income generated to its shareholders.
Meanwhile, European investors do have the option of choosing between a fund that will automatically reinvest dividend or interest income, and one that will pay it out directly.
Pros and cons of accumulating ETFs
- No transaction fees or trading costs for reinvesting your dividends – this will happen automatically.
- Can be tax-efficient if investors hold their units within a Stocks and Shares ISA.
Cons of trading ETFs
- There’s no passive income from dividends as this value will be reinvested automatically.
- You would have to liquidate your units to access the value from the dividends paid.
Also consider: Investment Trust vs ETF: where should I invest?
How do you know if an ETF is an accumulating fund?
Usually, you’ll be able to identify an accumulating ETF as it will be in the name or key information of the fund. This might be the phrase “(Acc)” at the end of the fund name, or it may appear somewhere high up on the webpage of the fund.
For example, if you look at the iShares Core S&P 500 UCITS ETF on the iShares website, you can see a dropdown menu displaying that it’s an accumulating ETF. You can also directly switch to the distributing version of the fund – you can find out a bit more about this later in my guide.
Do accumulating ETFs pay Dividend Tax?
In the UK, dividend income gains are taxed regardless of whether they are paid out. As a result, your holdings in an accumulation fund may be subject to Dividend Tax.
That said, each individual has a Dividend Allowance before dividend payments become eligible for tax treatment. In the 2022/23 tax year, this stands at £2,000.
However, it’s worth noting that the Dividend Allowance is to be reduced to £1,000 in April 2023, and then down to £500 in April 2024.
Any gains in your ETF units from dividend income that exceed your Dividend Allowance could be subject to Dividend Tax, with your tax rate determined by which Income Tax band you fall into. The Dividend Tax rates in the 2022/23 tax year are:
- 8.75% for basic-rate taxpayers
- 33.75% for higher-rate taxpayers
- 39.35% for additional-rate taxpayers.
Alternatively, you could hold your ETF units in a Stocks and Shares ISA to make them tax-efficient. Investments in ISAs are entirely free from Income Tax, Capital Gains Tax (CGT), and Dividend Tax.
As a result, you wouldn’t need to worry about paying Capital Gains Tax or Dividend Tax on any value generated by your units in an accumulating fund if they are held within the ISA wrapper.
What is a distributing ETF?
A distributing ETF, on the other hand, does the opposite to an accumulating ETF – as the name suggests, distributing ETFs will distribute dividends and other income to shareholders. Again, this could be dividends from shares or interest from bonds and loans.
With the fund paying dividends to you rather than reinvesting them, this offers you a method of generating a passive income.
The downside in choosing a distributing ETF is that you’d likely incur an extra expense in the form of trading fees or commission if you subsequently decided you wanted to reinvest the value into more units in the fund.
You might also miss out on investment returns that your units could have been generating while you held the dividends in cash before using them to buy more units.
As you saw above, you may also have to pay taxes with a distributing ETF if your dividends returns exceed your Dividend Allowance, especially as your dividend gains are realised in this case.
Again, as before, you could avoid having to pay this by investing through a Stocks and Shares ISA.
Pros and cons of distributing ETFs
- You can generate a passive income, as distributing ETFs pay dividends or interest out to shareholders, rather than reinvesting it automatically.
- Can also be held in a Stocks and Shares ISA, meaning you won’t have to pay Dividend Tax.
Cons of trading ETNs
- Dividends will not be automatically reinvested, meaning you won’t benefit from compound growth.
- You may incur more trading or commission fees if you decide you want to reinvest the interest or dividend paid out to you.
What is the difference between accumulating and distributing funds?
With accumulating funds and distributing funds, the clue is very much in the names: the former keeps dividends and reinvests them to accumulate value, whereas the latter looks to distribute returns to investors, whether that’s dividends or interest from bonds and cash.
Accumulating ETFs tend to be preferable for investors looking to generate returns over longer periods, whereas distributing ETFs are often more suitable if you’re seeking a steady cash flow from your investment.
Of course, nothing stops you from owning both in your portfolio, giving you exposure to both kinds and allowing you to make the most of the benefits that each has to offer.
Interestingly, some funds will actually have both an accumulating and distributing version, meaning they are essentially the same ETF with the same stocks and underlying holdings but with a different method of handling dividends.
For example, if you look at the same fund we discussed before, the iShares Core S&P 500 UCITS ETF, you’ll see that you can choose between the accumulation or distribution version of the fund.
That means you can achieve the same exposure to the S&P 500 with these funds while choosing whether any dividends paid or interest payments are reinvested in more assets, or paid out to you directly.
Is Vanguard’s VTI fund accumulating or distributing?
The Vanguard VTI (or “Total Stock Market”) ETF is very much a distribution fund, as it pays dividends on a quarterly basis.
You can read more about the Vanguard VTI fund on the Vanguard website.
Two funds that are examples of accumulating funds are:
- iShares Core S&P 500 UCITS ETF USD (Acc)
- iShares MSCI China A UCITS ETF USD (Acc)
Meanwhile, two ETFs that are distributing funds are:
- Lyxor New Energy UCITS ETF Dist
- Invesco S&P 500 High Div Low Vol UCITS ETF Dist
Also consider: My Best-Performing Vanguard ETFs to Buy UK guide
Accumulating vs distributing ETFs FAQs
What is the difference between an accumulation and a distribution fund?
Which is best: an accumulating ETF or a distributing ETF?
The best ETF for you will depend on your investment goals and risk tolerance. You should take these into account, as well as fund performance and transaction costs before you invest.
All investing involves risks and you may get back less than you invest.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.