This is a guide on how income and accumulation funds work to assist you in choosing the best investment for your money.
There is actually a pretty straightforward difference between income funds and accumulation funds. Each does what it states on the tin, with one ‘growing' (accumulation funds) and the other ‘paying' (income funds).
However, identifying what each entails and making use of that knowledge to pick the best unit trust, investment trust, or OEIC is entirely another matter.
How do investment funds work?
While the mechanics and pricing of different types of funds differ significantly, they all work on the same principles:
- Investors purchase ‘shares' in a fund
- Their money is joined together
- The fund makes use of its pooled capital to invest in specific assets
- Investors are rewarded based on the overall performance of the fund
The distinction that we are making is limited to point 4: how investors are rewarded.
Even the classic income fund that invests in fixed return assets can be set up for accumulation: it comes down to what the fund does with your profits
So what's the difference between the funds?
Whatever their underlying investments, Income Funds pay any profit to your nominated bank account. This means that you can withdraw the money instantly as an alternative income.
Usually, income funds buy fixed return assets such and securities and bonds. However, you could select a fund that invests purely in equity and still use it as an income fund by choosing to withdraw your profits.
On the other hand, Accumulation funds automatically reinvest your profits to acquire more shares in the fund. This means your stake in the fund increased, and your profit should rise exponentially over time as long as the fund performs well.
Investments should be treated as mid-term to long-term (generally more than five years). However, as most funds will give you the decision to choose between income and accumulation when you first invest, you are able to determine whether the investment is entirely geared to the future, or if you want to benefit from any income now.
Are income or accumulation funds safer?
All investments inevitably involve some risk: profit cannot be guaranteed, and the value of the fund can increase or decrease. Their intrinsic risk is almost equal since the safety of your money essentially depends on what the fund invests in.
- Securities, corporate bonds, and gilts are usually thought to be the safest options and will usually pay a fixed (however, usually lower) return.
- Stocks and shares are typically thought to have a greater inherent risk, but even this can be decreased by investing in a spread of ‘safer' businesses and markets.
Both accumulation and income funds restrict your risk by pooling your money with other investors. This raises their purchasing power so the fund can invest in a wider range of assets.
In a sense, income funds are somewhat safer since each withdrawal lessens your exposure. However, withdrawing the account earnings with every round of payments will restrict the growth of your total investment.
Investment Trusts are ‘closed-ended', meaning the fund is made up of a limited number of shares whose price is not directly connected with the overall investment of the fund; you can possibly buy underpriced or overpriced shares.
This also has connections to the question of Income vs. Accumulation. With a restricted number of shares available, they may not offer the facility to automatically have your profit reinvested. As such, if you are in it for accumulation, you will need to proactively buy back into the fund.
Should you choose income or accumulation?
If you require a regular income from your investments then an income fund lets you marry short-term benefits of a regular income with some features of a longer-term investment (the own shares or unit price of the fund).
Reinvesting your earnings through an accumulation fund, on the other hand, means that your investment will increase faster and with it, your potential for profit over time, assuming that the fund performs well.
If it performs poorly, even more of your money is invested and subject to risks of the stock market.
When it comes to deciding whether accumulation or income is the better choice for you, weigh up your short-term and longer-term needs.
Alternatively, you could explore other types of investments, such as premium bonds.
After that, you will need to compare investment funds and pick those with underlying investments that match both your attitude to risk and your goals.
Remember: As long as the fund continues to make a profit, the value of your individual shares in Unit Trusts or OEICs will increase too, so you could eventually sell them for a profit.