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. 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 companies pay dividends 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 mutual 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. 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. This 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. Sometimes, there is a significant difference in fees between distributing and accumulating funds.
Indeed, sometimes distributing funds has higher fees than accumulating funds. This 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 offers 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 as expensive as 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. However, 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 funds. 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 Distributing Funds and Accumulating Funds when FI. 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. So, you can cover half of your expenses with dividends.
If you have only Accumulating Funds, you must sell 4% of your principal yearly. All your expenses will be 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.
With accumulating funds, you will pay more transaction fees since you will have to sell more shares. Receiving dividends from a fund is free, but selling some shares is not!
Normally, capital gains are not taxed in Switzerland. And for most ETFs, we have seen that the tax efficiency is the same since the tax office will distinguish virtual dividends from real capital gains. As such, it should not matter for retirement either whether you are getting your dividends from accumulating or distributing ETFs.
Nevertheless, I prefer the clarity that distributing ETFs offer, on top of saving on transaction fees.
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. In Switzerland, they are both as tax-efficient.
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. 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 believe that distributing funds are a 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 Mr. Poor Swiss
Many thanks for sharing your vast knowledge!
“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 is keeping track of some ETFs in the ICTAX system. They will use this system to find out the dividends of your ETFs. …. If your Accumulating ETF is not in the list and you do not ask to add it, your full capital gains are going to be taxed as income!”
Sorry if my question sounds a bit silly. Obviously I don’t want to have my capital gain taxed as income! But does every fund has dividends (virtual or real)? My fund in SwissQuote has no any mentioning of them and ICTax also shows 0 in “Gross return” column (ISIN LU0215105999)
Thank you!
Hi Mastermind,
Not every fund has dividends, but funds without dividends are extremely rare. Indeed, most companies in the world are emitting dividends. Companies without any dividends are actually the exception (even though some large companies do not pay dividends).
Looking at the ISIN LU0215105999, it seems that this fund owns several companies which pay dividends, so there will be dividends. Since it’s accumulated, the dividends are virtual for your tax declaration, but you will need to declare them.
Very quickly looking at it, I can see that this fund is very expensive.
but how would I now the amount of virtual dividends if neither ICTax, nor Swissquote or my tax authorities tell anything about it?…Btw, this fund in not the exception, two other funds I have behave exaclty the same. They also exist on ICTax with 0 in “Gross return”
That’s a good question. In general, I would trust the numbers from ICTax, but it’s weird that it’s at zero. I would either use that number and see what the tax authorities say or ask ictax (or the tax authorities) directly.
Hi Mr TPS,
Great readings everywhere in your blog, thank you for that! :)
One remark from my side :
For someone with a salary or a decent rent at retirement, I think that the probability to realize capital gains larger than the salary/rent is rather low. Therefore the general rule in my opinion would be to hold a few accumulating ETFs and selling part of it once a year. The less different ETFs the better.
Even for an Early Retiree, I think that the capital gain part included in the total amount sold would be small and would not trigger significant tax even if considered as income. Moreover, you would have flexibility to decide when to realize capital gains, contrary to dividends which would be for sure considered as income and with no control on the timing.
Practical question for you regarding your frequent mention of the 15% taxation of dividends from US-based ETFs. In my case I still have 30% withold from the gross dividends received: (i) Impôt à la source USA and (ii) Retenue supplémentaire d’impôt. Is my understanding correct that (i) is recovered with Form R-US 164 and (ii) with Form DA-1 ? My broker is BCV – TradeDirect.
With accumulating Irish-based ETF, do you think that the two same forms have to be used + I have to compute the “estimated dividend” in order to recover the witheld amount ?
If anyone else has advice on accumulating ETF, I would be happy to read :)
Cheers!
Hi,
It’s correct that if you have a pension at retirement, this becomes easier because the capital gains would represent a smaller portion of your total taxable income.
In my case, I am assuming that we will have no pension and only live from our portfolio, following the FIRE idea.
Note that dividends will always be counted as income, even for accumulating ETFs. In Switzerland, you will pay the same taxes for both, whether you receive the dividend or if it’s accumulated into the ETF.
I am not that sure that’s correct. I believe you can only get back 15%, hence why yo should fill a W8-BEN form with your broker to ensure that you only get 15% withholding and not 30%. But I have never used your broker and never filled taxes with 30% withholding, so I don’t know if that’s correct.
With Irish ETFs, note that the 15% withholding for US dividends is irremediably lost because it is done before it arrives to your account, there is no way to recover it. And normally, nothing should be withheld by your broker.
Hi Mr. Poor CH,
I was wondering if I’ll be classified as a professional investor when selling my share of the accumulating ETF with no other sources of gain such as dividends. As you suggest in the article:
“And you are a professional investor if capital gains are more than 50% of your income. Therefore, to avoid taxes on that, you need your dividends to cover at least 50% of your income. It is crucial. And this makes it essential to hold distributing funds in Switzerland!”
However, in the other article, you mention the conditions to be classified as a professional investor and one of the rules is indeed “Capital gains of private investors do not account for more than 50 percent of their net income.”. Yet you point out that at least two conditions need to be fulfilled at the same time to be classified as a professional:
“You would need to violate at least two of these rules to be considered a professional investor in practice.”
So, if I understand correctly, you ain’t classified as a professional investor if this is the only condition you violate, right? Does this mean you can live off selling your shares of an accumulating ETF with no capital gain tax as well?
Btw., since you are really knowledgeable about the topic, do you know by chance if employees of international organisations are exempt from the dividend taxation in CH? I can’t google that information anywhere.
The last question, what if I hold shares but have no dividends whatsoever, do I need to fill the tax declaration as well?
Cheers,
Emil
Hi Emil,
To be honest, I am not entirely sure anymore about the rules for accumulating ETFs. Since you are taxed on them even though they are virtual, the capital gains on an accumulating ETF should be lower since the dividends have already been taxed. So, I do not think anymore that accumulating funds are so bad for retirement. I will have to update that in the article.
In theory, you could be classified with a single criterion violated, it’s always up to the tax office. However, in practice, a single criterion should not be enough. I know it’s vague, but that’s the system. You are only entirely safe if you met the 5 criteria.
Some employees of international organizations are exempt from all taxes. If you do not pay taxes in Switzerland as such, you do not have to worry about capital gains in my opinion. But again, if you want to make sure, contact the local tax office.
Even if you get no dividends, you have to fill the declaration since you will pay wealth tax on them.
Hi,
Thank you for your prompt reply. I contacted the tax office to confirm all of the details and waiting for a reply. I verified so far, though, I am exempt from the capital gain taxes yet not sure about the dividends’ tax.
Have a good WE,
Emil
Hi TPS,
I have one question regarding the capital gains and how they’re calculated in Switzerland: are the tax authorities using a FIFO type logic (the capital gains would be based on the selling price less the purchase price of your oldest shares) or using an average costing model?
The reason why I am asking this: in retirement, when you sell shares, only part of the proceeds would be considered capital gains I guess. This means that you would need less than 50% of the amount one would need to cover expenses coming from the dividends (dividends need to be 1CHF more than your capital gains, and not more than the total proceeds from selling shares). This makes it easier to still manage to avoid the capital gains tax, while still holding a significant part of your investment in accumulating ETF’s.
Best,
Adrian.
Hi Adrian,
Yes, only parts of the proceeds will considered capital gains. But I have no idea what model they are using to select the capital gains.
But it’s a good point that I considered the entire sale as capital gains, while I should have only considered the “capital gains” part. Depending on how much capital gains you made, this may not be such an issue as I thought!
Hi!
“Indeed, sometimes distributing funds have higher fees than the accumulating funds. It is especially true for European Funds by iShares. A lot of their accumulating are more expensive than their distributing funds for the same index.”
Is there a mistaken inversion here?
Hi Joh,
You are absolutely right. Thanks for pointing that out! I have fixed that in the article (may take a while for cache to refresh).
Hi Mr.The Poor Swiss,
maybe here there is also somethings that depends on the broker:
“There are two differences here. First, with Accumulating Funds, you will pay more transaction fees since you are going to have to sell more shares. And receiving dividends from a fund is free”…
With ‘DEGIRO Custody” there is the ‘dividend fee’ that was already discussed above, so receiving dividends depends on the broker, right?
Cheers!
Hi Tiago,
Indeed, the cost of receiving dividends can be different from broker to broker. So, people indeed have to take that into account!
Good point!
Great article and depth. As a Belgian investor working mainly with ETFs I have historically always preferred accumuling funds from a tax perspective. As we have been living 4 years in Switzerland (expat) and now we will permanently stay in Switzerland and shift our retirement portfolio to a swiss broker, this is extremely useful information! Thanks a million!
I am glad this was helfpul :)
Good luck with your investing!
Hi. Thanks for your blog, it is+has been a great resource for me to finally start investing my savings!
I have one question regarding the distributing funds: since my degiro account is in CHF and most of my ETFs (VWRL) are in USD, am I not losing money with the currency exchange when I manually reinvest my dividends?
Thanks!
Hi Mark,
That’s a good question. With DEGIRO, I guess you are going to lose some money on dividends for conversion indeed. It could be a point in favour of accumulating funds.
With Interactive brokers, we do not have this issue since we can keep cash in multiple currencies.
Thanks for stopping by!
Thanks a lot for the explanation! really clear.
I am glad it was useful :)
Hi Thepoorswiss,
Thanks a lot for such useful information!!
One idea/question. You say that you don’t pay for capital gains in Switzerland until it’s more than 50% of your salary. Does it mean that we could have an accumulative ETF so that we pay fewer fees or maybe because it’s the only one available at that point, and then at some smart point, change it into a fund (same or different) that distributes dividends? e.g., before the gain would be more than 50% of the salary? Does this make sense? can you help me elaborate this way?
Basically, I’d like to buy an ETF that doesn’t have a good option for a distributing option in Interactive Markets.
Again, thank you!!
César
Hi Cesar,
Yes, this would probably work. During the accumulation phase (when you have a salary), you could imagine having an accumulating option since the dividends won’t be really useful and there are no tax differences.
And then, in the distribution phase (when you are withdrawing), you could switch to a distributing option. Now, selling and buying may trigger some transaction costs but with a good broker, this should not matter.
On the other hand, this will trigger some possible large capital gains. So, you would have to worry about that. This means you have to do that when you still have a salary.
Now, in most cases, we do no have to worry about capital gains tax in Switzerland unless we are a real professional investor. But I would still be careful in not generating too many capital gains after I retire.
Thanks for stopping by!
Hi Cesar,
Yes, this would probably work. During the accumulation phase (when you have a salary), you could imagine having an accumulating option since the dividends won’t be really useful and there are no tax differences.
And then, in the distribution phase (when you are withdrawing), you could switch to a distributing option. Now, selling and buying may trigger some transaction costs but with a good broker, this should not matter.
On the other hand, this will trigger some possible large capital gains. So, you would have to worry about that. This means you have to do that when you still have a salary.
Now, in most cases, we do no have to worry about capital gains tax in Switzerland unless we are a real professional investor. But I would still be careful in not generating too many capital gains after I retire.
Thanks for stopping by!
Not sure if i got all this right. As a Swiss citizen, will the tax you pay in your dividends on for example a S&P500 have negative impact on your compounding effect? I plan to compound 50k for 20years, so important nothing impacts this. People spend much time trying to save on the TER for ETF’s but is the tax the overruling negative impact on your compound effect?
Additional question: What is likely to have negative impact on the $S&P500 ETF compounding effect as a Swiss? And is there an advantage in buying EUR or CHF ETFs over USD ETF’s.
I use Degiro and my income is CHF. Considering IB but it seems less beginner friendly so didn’t switch yet.
Hi Tim,
I am not sure I understand your question. In the stock market, two things are compounding: dividends and capital gains (when unrealized). Generally, they are counted together as the performance of the stock market.
So, yes, the tax will eat a part of what you call the compounding effect.
If you get a U.S. ETF, you will pay taxes on the dividends. 15% will be withheld directly by the Swiss Tax Office. This can be reclaimed as already paid in your tax declaration.
From a tax point of view, there is no difference in having EUR, USD or CHF ETF. What is important is the domicile of the ETF.
IB is definitely less friendly. It will help you save some extra money on dividends by using U.S. ETF. You can use it if you really want to optimize. However, if you have only 50K, it may not be great since you will have to pay custody fees for several years.
Thanks for stopping by!