The Motley Fool

Accumulation vs income funds: which should you pick for your ISA or SIPP?

One of the most confusing things about investing in mutual funds when you’re starting out is that each fund often has multiple share classes. More specifically, you’ll often find that each has an ‘accumulation’ share class and an ‘income’ share class. For example, a glance at Neil Woodford’s Equity Income fund on the Hargreaves Lansdown platform reveals that there is a Woodford Equity Income Class Z – Accumulation version of the fund, as well as a Woodford Equity Income Class Z – Income version of the fund.

So, what’s the difference between an accumulation fund and an income fund? And which is the best share class to invest in?

Accumulation vs income funds

The difference between accumulation funds and income funds is a very easy investment concept to understand.

Essentially, if you buy an accumulation fund, all income from its assets, including dividends and interest, will be automatically reinvested into the fund for you at no extra cost.

In contrast, if you buy an income fund, the income earned from the assets will be paid to you in cash each year, often on a quarterly or semi-annual basis.

That’s it really. As I said, it’s a simple concept to grasp. The only difference between the two share classes is that the fund income is treated differently. So, which is the better share class to invest in?

Which is better?

Whether you pick an accumulation fund or an income fund will ultimately depend on your investment objectives.

Broadly speaking, if you’re looking for regular income now from your investments, then an income fund may be the more suitable choice. So, for example, if you’re retired and looking to live off the income generated by your investments, or supplement your State Pension, then the income variety could be the most appropriate option as you’ll receive cash payments into your account on a regular basis.

On the other hand, if you’re looking to grow your capital over a longer period of time and don’t require any income from your investments in the near term, an accumulation fund could be a better choice. The reason for this is that accumulation units will benefit from the power of compounding because the income is reinvested, meaning you’ll earn a return on your past returns. Because compounding is such a powerful force in wealth building, reinvesting fund units could make a big difference to your overall wealth over time.

Of course, if you were invested in an income fund, you could simply reinvest your income into the fund to take advantage of the power of compounding. However, as my colleague Roland Head recently explained here, the reinvesting process is far more seamless when you invest in an accumulation fund as the transaction costs are significantly lower, and this tends to result in much higher returns over time.

Summary

In summary, accumulation funds reinvest all income generated by the fund’s assets, while income funds pay out the income to investors on a regular basis. Which share class is the most appropriate will depend on your own personal requirements and whether you need investment income now, or are happy to invest for the long term and compound your earnings. 

Want To Boost Your Savings?

Do you want to retire early and give up the rat race to enjoy the rest of your life? Of course you do, and to help you accomplish this goal, the Motley Fool has put together this free report titled "The Foolish Guide To Financial Independence", which is packed full of wealth-creating tips as well as ideas for your money.

The report is entirely free and available for download today, so if you're interested in exiting the rat race and achieving financial independence, click here to download the report. What have you got to lose?

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.