Accumulation or income funds: which is right for your portfolio?

Income is an important component of returns for many assets. In the UK stock market, for instance, income from dividends has accounted for 70% of total returns over the past 20 years (Source: FE Analytics, data to 01/08/24).

In the US it is much less (at around 27%) as companies have a tendency to spend more of their earnings on buying back their own shares, or investing to expand the business, rather than paying dividends. However, these alternative uses of cash produced by the business can also be seen as forms of income reinvestment.

For bonds – loans to institutions who wish to raise finance – all or most of the return is typically income. In the case of corporate bonds, the borrower is a company, and for gilts it is the UK government. The income represents the interest on those debts. For other investments such as property or infrastructure, the return can predominantly be from income, too.

How can funds spread the risk of investing for income or growth?

Whether you’re investing for income or growth, it is usually possible to invest in these assets directly. Either to buy into an income stream to supplement other income, for instance in retirement, or to reinvest in the same or other investments to benefit from compounding.

Either way, one convenient way to invest is through funds and other ‘collective’ investments. These products spread investment risk across a number of shares or other investments, so you are not too reliant on one or a small number of them. Units in funds such as unit trusts and OEICs are available in two main types: income and accumulation. Income units (abbreviated to ‘inc’) pay out the income so that it can be collected by the investor, whereas accumulation units (abbreviated to ‘acc’) retain any income to boost the unit price. Some funds may carry the abbreviation ‘Dis’ – which standards for ‘distribution’ – instead of Inc – but it amounts to the same thing.

Owners of income or distribution units can reinvest the income in more units if they want to, but the accumulation units offer a more convenient, automatic way of doing this. You will find that certain funds are only available as accumulation units reflecting the fact that they have no particular income objective or that the underlying assets pay little or no income. Often the aim of the fund is evident from the fund name, which may contain ‘growth’ or ‘income’ in the title. You can also look at the yield of the fund (see below) to establish whether it pays income and roughly how much that might be.

If your investment objectives don’t involve taking income then you should generally look to buy accumulation units. Otherwise, you will end up with cash arriving in your account which you’ll have to reinvest yourself. In contrast, if you want to generate income and have it paid to you, you should select income units and set your Charles Stanley account to pay the income to your nominated bank account.

Some Exchange Traded Funds (ETFs) also come in two different forms, one that pays out income to investors that want it, and another that rolls it up to increase capital value. For instance, iShares Core FTSE 100 UCITS ETF, which tracks the performance of the FTSE 100 Index, has both distribution and accumulating shares available.

Investment Trusts, meanwhile, tend to set a dividend policy according to their investment focus and objectives. Some will generate and pay out significant income, others little or none. It is worth noting that investment trusts can sometimes have advantages over other types of investment when it comes to providing income due to their ability to hold reserves and ‘smooth’ pay-outs from underlying assets that provide ‘lumpy’ income returns. This can be important if you’re looking for consistency of income.

Read more: How to choose an Investment Trust

Should you invest for income or growth?

When taking income from your investments it is not necessarily a case of just selecting income-producing investments. It is also possible to invest to maximise ‘total return’ and then sell assets to help provide the money you need. Just taking the ‘natural income’ investments produce can restrict you in terms of maximising returns because low-income areas are excluded, and these might perform better than low or non-yielding assets. Consider, for instance, technology shares which have performed well over the past decade but produced little in the way of dividend income.

However, the natural income approach means you can avoid selling investments and reducing your capital and it ensures this remains intact to generate future income. But it relies on the natural income meeting your needs on its own.

For investors looking solely for growth investments, or to maximise returns generally, there is no compromise to be made over an income strategy. However, neglecting income-producing assets completely could lead to an unbalanced and higher risk portfolio.

Income-producing assets such as dividend-paying shares, bonds, infrastructure and property can provide a steady stream of cash that can be reinvested elsewhere. This keeps up a constant stream of returns even when markets are unfavourable. As such they can lend stability to all investors’ portfolios, not just those that require income.

Read more: How to generate income from your investments

How can you measure income from funds?

You can get an idea of how much income an investment produces by looking up its ‘yield’. Generally, this is the amount of income it has paid over the past year divided by its price, and it is expressed as a percentage.

For instance, a share valued at £1 that has paid 5p per share in dividends from its profits over the past year has a yield of 5%. This could be different going forward because the dividend could be higher or lower, plus of course the price might change, but it can give a useful indication of the possible income on offer.

Although it can be useful to compare yields to the interest rates available on cash it should be noted that interest rates vary. Although they have risen a lot over the past year, they can move higher or lower from this point. Shares and other assets such as property have the potential to provide a growing income over time, albeit it too is variable and not guaranteed. Bear in mind that high yields often signal high risk.

Yield calculations apply to funds as well, and you’ll find yield data for every fund on its individual website page and its factsheet. It’s also important to note that some yields you may come across are forward looking or ‘prospective’ rather than historic, and this is especially the case with bonds and bond funds. You should always regard yields, and income from investments more generally, as variable and not guaranteed.

Investment ideas

If you are looking for investments to fill a gap in your portfolio our Preferred List could help. This collection of investments is chosen by our Research Team to represent our best ideas across the major sectors.