Distributing Funds vs Accumulating Funds: Which is better?
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It can be challenging to choose between Distributing Funds and Accumulating Funds when you need to choose two funds. And the problem is also the same when you must compare two Exchange Traded Funds (ETFs).
An accumulating fund (or ETF) will keep the dividends and reinvest them. On the other hand, a distributing fund (or ETF) will distribute the dividends to the shareholders.
This article will discuss the details of these two options and their pros and cons. By the end of the article, you will know whether you should use accumulating or
Distributing Funds vs Accumulating Funds
Most shares pay a dividend to their shareholders. If you hold shares of a company paying a dividend, you will receive cash dividends several times yearly. Since a fund holds many shares, every fund will receive dividends. Once a fund receives a dividend, it must return it to the real shareholders: you!
There are two ways for a fund or an ETF to give the dividends back to the investors:
- It can give back the money directly in cash to the shareholders. Such a fund is a Distributing Fund (or ETF), also called an Income Fund.
- Or, it can reinvest the dividends directly into the fund, increasing its value. Such a fund is an Accumulating Fund (or ETF) or a Growth Fund.
Whether you talk about funds or Exchange Traded Funds (ETFs) is the same in this context. A Distributing ETF is simply a Distributing Fund traded on the stock market.
We will go over the differences between Distributing Funds and Accumulating Funds.
Taxes
Capital gains and dividends are often taxed differently depending on which country you are in.
In the United States, you will pay taxes on capital gains and dividends. They are taxed at different rates unless you hold securities for less than a year. On the other hand, in Switzerland, capital gains are not taxed for private investors. And dividends are taxed as regular income at your marginal tax rate. We start to see the difference between the two types of funds with Swiss taxes.
Taxes in Switzerland
Now there is a myth saying that you will not pay taxes on the dividends issued by accumulating funds. This myth is entirely wrong! In Switzerland, you will pay the same amount of taxes regardless if you get the dividend or if it is reinvested directly into the fund.
In Switzerland, accumulating funds are considered to have a virtual dividend. And they will be taxed as if they distributed this virtual dividend. The Swiss Tax Authority keeps track of some ETFs in the ICTAX system. They will use this system to find out the dividends of your ETFs.
If your ETF is not on this list, you can ask them to add the ETF to the list. If your Accumulating ETF is not on the list and you do not ask to add it, your full capital gains will be taxed as income!
So, from a tax point of view, there is no advantage to either type of fund. However, it is easier in Switzerland to declare dividends rather than virtual dividends since you are sure you will not pay taxes on your capital gains.
To learn more, read my complete guide about taxes in Switzerland.
Taxes in other countries
For other countries, it depends on the tax system.
In the United States, the IRS withholds all the dividends at the source, so there is no difference. For instance, I know that in the United Kingdom, it is also easier to work with distributing funds.
On the other hand, in Belgium, it is more efficient to get an accumulating fund. Indeed, the Belgian tax office taxes dividends on distributing funds, and an accumulating fund allows them to bypass this tax. And in Germany, you will save money by having a distributing fund.
Therefore, it is essential to know your tax system. For most people, it is not an interesting subject. However, if you want to save money on taxes, you should know the details of your country’s taxes.
Tax Withholding
In many countries, tax services are withholding dividends. It is the case in the United States, where most of the world stock market value is. So you will probably have some U.S. securities in your portfolio. If these securities are paying a dividend, the U.S. Internal Revenue Service (IRS) will withhold some of the dividends.
The IRS withholds 15% for U.S. citizens and 30% for non-U.S. citizens. There is an exception for citizens of a country with a tax treaty with the U.S. (like Switzerland). In that case, these citizens only get a 15% withholding.
Once again, there are no differences between a distributing or an accumulating fund for this case. In Switzerland, in both cases, you can declare the withholding with a DA-1 form in your tax declaration. That means the withheld money will be counted towards what you have already paid in taxes.
For Swiss securities, this is also the same. If you live in Switzerland, you likely have Swiss securities. If they pay a dividend, Swiss tax authorities will withhold 35% of the amount. But, they will not withhold dividends for the accumulating funds. You will still pay taxes on these dividends.
Transaction Fees
When you buy or sell shares of a fund in your broker, you will have to pay some fees for the transaction. For some mutual funds you directly own from your bank, it may be free to sell and buy shares.
If you have a Distributing Fund and you want to reinvest the dividends, you will have to pay some transaction fees to do it.
However, it is not as bad as it sounds. If you are in the accumulation phase, you invest almost every month. At this time, you can simply invest the dividends with the new capital. And if you are early retired, you will use the dividends anyway.
Fund Fees
The fees of a fund, its Total Expense Ratio (TER), is something fundamental when you compare two funds. And sometimes, there is a significant difference in fees between distributing and accumulating funds.
Indeed, sometimes distributing funds have higher fees than accumulating funds. It is especially true for European Funds by iShares. Many of their accumulating funds are cheaper than their distributing funds for the same index.
For instance, for the MSCI World index, iShares offer two funds in Europe:
- iShares Core MSCI World UCITS ETF (Acc) with a TER of 0.2%
- iShares MSCI World UCITS ETF (Dist) with a TER of 0.5%
The distributing fund is more than twice more expensive than the accumulating fund. It is a huge difference! Fortunately, there are better funds from other providers. However, if I had to choose between these two, I would use an accumulating fund for once.
You may not realize it, but investing fees are very important. You need to pay attention to them!
Performance
Comparing two funds that have different dividend distribution policy is complicated.
If you directly compare the performance of an accumulating fund and a distributing fund of the same index with the same fees, the accumulating performance should be better in the long run.
It is logical since the dividends are reinvested directly and compounded over time. But this does not mean that an accumulating fund is performing any better than a distributing fund. Both types of funds have the same performance. It just means that it is more difficult to compare them.
In the case of the distributing fund, you will also have some amount of cash that you can use. Of course, if you splurge on the dividends, you will be poorer than if you had the accumulating fund. But if you reinvest them., you should have the same amount in the end.
In practice, you should be fine. Most ETF comparison platforms show you the performance as if the dividends were reinvested into the fund. For instance, this is what justetf does. It makes it possible to compare the performance of two funds with different distribution policies.
Convenience
The big practical difference between accumulating funds and distributing funds is the inconvenience.
Accumulating Funds are much lazier than Distributing Funds. You do not need to do anything with the dividends. The fund will reinvest the dividends for you.
On the other hand, if you have distributing funds, you will have to do something with the dividends that are sleeping as cash in your account. That means you will have to invest it in one of your funds.
I do not think it is too bad. At most, you will receive one dividend from your funds each month. And it is much more likely that you receive one dividend per fund per quarter since most big funds are paying dividends only each quarter.
Since you should invest every month anyway, it should not be an issue to make a slightly bigger trade. And we have already seen that for filling out the tax declaration, it is generally more convenient to have a distributing fund.
Rebalancing
When you have several funds in your portfolio, you may want to rebalance the funds periodically.
If one fund performs worse, you will need to buy more shares to bring the balance back to your target allocation. On the contrary, if one fund is performing well, you may want to stop investing in it or sell some shares until your allocation returns to normal.
Receiving dividends can give you an edge for rebalancing. Since you have extra cash, you can invest this cash based on where your allocation is out of balance. That means the dividends from your most-performing fund could be reinvested in the worst-performing one, bringing back balance. Distributed Dividends can help you rebalance!
Financial Independence
Now, we will review the main difference between Distributing Funds and Accumulating Funds. Whether you hold one or the other can make a tremendous difference when you reach Financial Independence.
If you are financially independent and live on your net worth, you must use your principal to cover your expenses. For example, you need 4% of your principal to cover your expenses. And we will assume you get 2% dividends from your funds.
If you have only Accumulating Funds, you must sell 4% of your principal yearly. All your expenses will get covered by selling your funds. If you have Distributing Funds, you can cover half of your expenses by selling the funds and half of your expenses using the dividends.
There are two differences here. First, with accumulating funds, you will pay more transaction fees since you will have to sell more shares. And receiving dividends from a fund is free, but selling some shares is not! But most importantly, you will have much more capital gains. You will not have any income but only capital gains.
In some countries, this is not so bad. But in Switzerland, capital gains are not taxed unless you are considered a professional investor. And you are a professional investor if capital gains are more than 50% of your income. Therefore, you need your dividends to cover at least 50% of your income to avoid taxes. It is crucial. And this makes it essential to hold distributing funds in Switzerland!
If you are not in Switzerland, it will depend on your taxation system. But in most countries, it is better to get dividends than capital gains. And therefore, in most countries, it is better to hold distributing funds rather than accumulating funds!
FAQ
What is a distributing fund (or ETF)?
A distributing mutual fund is a fund that passes the dividends directly to the shareholders. Generally, shareholders will receive dividends every quarter.
What is an accumulating fund (or ETF)?
An accumulating fund is a fund that uses the received dividends to purchase more shares of the companies. The shareholders of the funds will never receive a dividend.
Should I prefer distributing or accumulating funds?
This depends on your country. You should prefer the funds that are the most tax-efficient. In most countries, this will be distributing funds. But in some European countries, this will be accumulating funds.
Conclusion
Overall, Distributing Funds are superior to Accumulating Funds. They will be much more useful once you are financially independent and ready to retire. You will need cash to cover your expenses. And the dividends will do exactly that. And they are generally more convenient from a tax point of view. They can also help you rebalance your portfolio more efficiently.
Contrary to some popular belief, accumulating funds are not more tax-efficient than distributing funds. You will pay the same taxes regardless of which you use. And in most countries, it is easier to declare dividends for a distributing fund than for an accumulating fund.
The only advantage of an accumulating fund is the convenience it offers. However, I believe that this convenience is a bit too lazy. You would be better off investing the dividends according to your allocation rather than blindly allocating it to each fund that generates them.
For all these reasons, I strongly believe that distributing funds are a much better option than accumulating funds. When I compare index funds, I generally only consider distributing funds. Only when no good distributing fund is available for an index will I consider accumulating funds.
Now, this stands true for Switzerland. In some other countries, it will not be true. In Belgium, it is better to hold accumulating funds. On the other hand, in Germany, it is also better to hold distributing funds. And in the United States, it makes no difference. Therefore, you must know the details of your tax system if you want to save money!
To learn more about funds, read how to choose index funds and ETFs. Or, if you have already decided which fund you want, read how to buy an ETF with IB.
What about you? Which kind of fund do you prefer and why?
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Hi,
Thanks for all of the articles.
I am a bit confused by this article, is it not in contradiction with the one about capital gain? In the capital gain article, it is written that in Switzerland capital gains are tax-free (and you gave the example of ETF shares that you sell at a higher value). Here you’re saying that accumulating funds have a virtual dividend that will be taxed, so an increase in value of the accumulating ETF share is not considered as capital gain? So is the capital gains only tax-free in Switzerland for stocks or is it due to the country issuing the accumulating ETF (taxed for CH-domiciled ETF but not for US/Ireland domiciled ETF?)
Many thanks
Hi Lina,
Capital gains are indeed tax-free in most cases.
The difference between a distributing ETF and an accumulating ETF is that the former gives you the dividends while the latter reinvests them directly into the fund. But there are still dividends in both cases, they are not just distributed the same way.
So, in theory, there could be a tax advantage to have accumulating ETFs. To avoid this, the Swiss taxes include this special rule about accumulating funds where the dividends will be taxed as income even if they are not distributed. So the returns of an accumulating ETF is made of two portions:
* the dividends, which are taxed as income
* the capital gains, which are not taxed (usually)
This makes distributng ETFs and accumulating ETFs on the same level for taxes.
Hello Baptiste,
first, congratulations for your blog, it is really useful and interesting!
I just wanted to note one thing about paying taxes in accumulative funds/ETFs. Typically it is said that paying taxes in Switzerland is more advantageous regarding investments, as one only pays dividends but not for capital gains. And that this is also true for accumulative funds/ETFs, where there is this “virtual dividend” concept.
In this case, I have found that the Swiss taxation system may be worse than in other countries. If you purchase some accumulative ETF during a couple of years without selling, you will be paying during these years these “virtual dividends”, but in reality you will be seeing no real money, as you have no got withdrawn anything. So you are paying taxes for nothing.
At the end of the years, you will not pay anything for withdrawal, this is true though. But imagine that this ETF has not grown in value over the years. It stayed the same or even reduced its value. You will have paid these virtual dividends for something that made you lose money!
If this was done in other more typical countries, where you pay normally for capital gains and dividends, but accumulative ETFs are considered only as capital gains, you would end paying nothing, as you earned nothing.
Am I wrong or is something I am missing out? Because to me it sounds like a really great disadvantage when investing in Switzerland!
Hi Dani,
I don’t think I agree.
Accumulating ETFs are exactly the same as a distributing ETF IF you reinvest everything into the fund directly. In this case, both ETFs have exactly the same behaviour and tax efficiency.
But it’s true that distributing ETFs are more practical because you can do what you want with the dividends. However, most investors will (and probably should) reinvest the dividends in the ETF anyway, so it would not matter much.
Yes, I agree with you. I was referring to the comparison between investing in an accumulated ETF in Switzerland or doing the same in another “more typical” country.
I meant that, until you sell your ETF, you pay nothing in any other country and you still not pay when selling if the ETF didn’t grow up in value.
In Switzerland you still pay these virtual dividends regardless the ETF goes up or down (then you won’t pay when selling).
So, it could be worse in term of taxes in Switzerland compared to other countries if the ETF does not grow (which for me is surprising, because it seemed very advantageous at first).
You are right that in some situations, this could be worse for taxes in Switzerland.
However, for long term passive investors, the situation is still probably better on Switzerland. Because on average, you get maybe 2% dividends but hope for 5-6% capital gains. So I’d rather pay taxes on 2% than on 6% :)
Hello,
Not sure is the right article to post this question but as it is related to withholding taxes on ETFs I thought of asking here and it could help others too.
I was advised to look at the type of ETFs that are Ucits (harmonized funds) or Non-Ucits (non-harmonized funds). It seems that those Ucits are EU-based (w/ US securities) and therefore do not withhold dividends. An example for Russell 2000 would be SPDR vs VTWO.
1) is this true or not?
2) in case that is true, they do not charge any withholding at all? Not even the 15% remaining for non-US citizens with the Swiss-US treaty?
Any other feedback or thoughts you consider important would be appreciated.
Many thanks!
Hi bapt,
1) UCITS simply mean it’s an european ETF that can be used by European investors. It’s a regulatory term. For withholding, it depends on which country. But if you take an Ireland ETF for a Swiss, it’s true that they will not withhold any dividends.
2) It’s more complicated :) The ETF itself will not withhold dividends. But the US will withhold dividends before sending them to the ETF. That’s where the 15% are lost.
Great post as always!
Basic question, how do I tell from the Interactive Brokers if an ETF is Accumulating or Distributing? I am looking at the ones you typically suggest like VOO, VT and CHSPI but don’t seem to be able to find it out.
Thanks!
Hi bapt,
From Interactive Brokers, I am not sure how to do it. I do my research outside of IB. It’s extremely easy to find that on Vanguard website for instance.
Hi Mr. Wicht,
Thanks for the informative article.
There appears to be third alternative you didn’t mention, between the distributing and accumulated funds.
For example, suppose I buy a Swiss-domiciled Distributing fund that pays an annual dividend in December.
I buy the fund on May 1 for 1000 CHF and sell the fund 3 months later for 1005 CHF on August 1. I make 5 CHF profit but because this is not accumulating fund I don’t pay withholding tax on accumulated profit. Also since I sell before dividend distribution, obviously no dividend withholding tax either. So I make a clean profit of 5 CHF.
Is my analysis correct?
Hi
It’s true that if you sell and buy at the proper dates you can avoid the dividends. But there are major disadvantages to your idea
* Most ETFs will pay dividends 4 times a year, so you have to sell and buy 4 times a year. This means big transaction costs
* You will need to be out of the market for a few days a year, possibly missing on returns
* You will likely be triggered as a professional investor, so you will pay capital gains tax, removing all advantages of your strategy.
Yes, thanks for that analysis.
I suppose my strategy works for a Swiss-domiciled money market Distributing fund.
Just sell before annual dividend and you owe no capital gains or withholding tax.
Hi,
Thank you for this article. I am struggling to decide between VWCE (accumulative) and VWRL (distributing). Since I am kind of lazy and just want to DCA each month from my salary for the next 20+ years, if I choose distributing ETF I would just reinvest back in, however for the accumulative ETF this would happen automatically. Isn’t it better for me to choose the accumulative option? Also tax for dividends from VWCE accumulative ETF is calculated automatically.
Hi Baptiste, I just made my first investment today buying WVRA. I was considering VT but knowing that being a non-EU citizen who moves around as a global expat and may not benefit from the Swiss tax system and US-Swiss treaties forever, I went with Irish-based ETF. However, I’m now questioning my decision to be lazy and just by an accumulated ETF. If I want to switch to the distributing version, do you recommend I sell my recently purchased VWRA and buy new WVRD shares or keep what I bought and buy VWRD with my new invested money? Moving soon from CH to Japan for a 4-year assignment, I was really tempted with VT and it’s super low TER but the risk of working/living somewhere else with no US tax protection is just overwhelming :)
Hi T,
I prefer distributing, but overall, the difference is not huge between both.
If you want to switch, I recommend selling the previous one directly and buying the new one. It’s not worth keeping. By keeping it you would save a few transaction fees, but I think having a single ETF is worth that small fee.
Hi IB, thanks for the advice. Digging in more into your blog and given that Japan also has good tax treaties with the US, I will sell my WVRA and invest in VT. I just want to ask a silly question, if I ever move to a country with no tax protection, should I sell my VT and replace it with WVRL/A gain? I really want to be simple and stick to an ETF for a long-run but I guess changing domicile will lead to more complications :(
Hi T
No, you can keep VT regardless of the tax treaty. I think that VT without a tax treaty is more or less the same as VWRL.
Hi there
First of all, thank you for this great blog! It is very useful and the articles are very well structured.
My questions is about the time of dividend taxation in Switzerland. Of course one has to declare dividends as income at the end of the year but if I’m not wrong, there is also another taxation (15%?) one gets back when declaring all dividends. This second taxation is deducted as soon as the dividend is payed out. Therefore, this money can’t be invested for a year which would reduce the return compared to accumulating ETFs.
Furthermore, dividends are not immediately paid out. Therefore, dividends can’t be reinvested until they are paid out. Again, this would increase the return of accumulating ETFs.
Did I understand something wrong? Am I missing something?
Hi Jul,
That’s correct, this is a dividend withholding. It’s 35% for Swiss stocks and 15% for US stocks. You can get that back by declaring it in your tax declaration. And in the end, the dividends will indeed be added to your taxable income.
On the other, with accumulating dividends, you don’t pay out this withholding, you will pay the full amount later on.
In theory, it’s true that if dividends are reinvested on the same day, there could be a tiny advantage to accumulating funds since distributing will keep the money and distribute it (generally), once a quarter. Now, nothings guarantees you that the accumulating ETFs will do a reinvesting on the same day, but in theory, they should.
So, yes, this could be a tiny advantage in returns for accumulating ETFs.
Hello,
Can you give some ETFs recommentation for beginners?
I have been trying to find some low fee Dist ETFs to start but there is so many options, that the process has been incredibly confusing.
Thank you so much
Hi Janet,
I have an article about a good ETF portfolio for Swiss investors. This should help.