Choosing Between Dividends and Reinvestment: Understanding Your Options
If you're delving into the world of investing, one decision you'll need to make is whether to opt for a distributing or accumulating fund. Both types of funds have their advantages, and it's essential to understand the differences before making a choice.
Funds with a distributing nature dispense profits, such as dividends or interest, to investors, while accumulating funds re-invest the earnings to buy new shares, thereby increasing the fund's overall value.
The Power of Accumulation
Accumulating funds can provide a higher return in the long run due to compound interest. With this strategy, the profits are reinvested, and the value of the fund increases as new shares are purchased. Over time, this leads to substantial growth in the fund's worth.
However, reinvestment isn't always straightforward with distributing funds. In many cases, transactions involved in buying new units can incur additional costs. Some banks may offer automatic reinvestment, but savers often need to take the reins themselves.
The Case for Distributing Funds
Distributing funds may prove advantageous in certain situations. They may be a suitable choice for individuals who need regular income. Dividends are paid out automatically and cost-free, allowing investors to manage their cash flow more easily.
Moreover, the immediate impact of dividend payouts can motivate certain investors. A visible return is a powerful incentive to stay invested and keep up interest in their portfolio.
Keep in Mind: Selling Shares for Regular Income
It's worth noting that both accumulating and distributing funds can yield compound returns if the dividends are reinvested. If an investor is using a distributing fund and wishes to benefit from compound returns, they should consider reinvesting the dividends themselves.
The Question of Dividend Stocks
Some funds distribute profits yearly or even twice or four times a year. However, the amount that will be paid out is never definite. According to JustETF, ETFs of the popular MSCI World index have an average dividend yield of just under 2%.
To generate a supplementary pension, a large savings account is generally required. For example, an average distribution of 200,000 euros would provide around 333 euros a month.
Dividend ETFs are available, offering particularly high payouts. However, these funds invest in companies that have traditionally distributed significant portions of their profits as dividends. While high yields may seem appealing, it is crucial to proceed with caution.
A high dividend yield is often calculated by dividing the dividends by the price of a fund share. Poor performance, resulting in low share prices, will correspondingly elevate the dividend yield. Established companies, often associated with sluggish growth, may offer high dividends.
Embrace Tax Neutrality
Until 2018, tax rules varied between distributing and accumulating funds. However, reforms have made this distinction less relevant. The tax liability for both types of funds is now the same, and the investor's allowance can be utilized in either scenario.
Accumulating funds necessitate annual advance lump-sum deductions, while taxes are simply deducted from distributing funds' dividends. It is vital to allocate a buffer in a settlement account for the annual advance lump-sum deductions. If a buffer cannot be maintained, distributing funds would be a more appropriate choice.
Combining Strategies for Maximum Benefit
Investors may combine the two strategies to ensure that they reap the benefits of each approach. For instance, selling accumulating shares before retirement to generate a supplementary pension while maintaining distributing funds for a steady income stream after retirement.
However, one error investors should avoid is selling the accumulating fund close to retirement before investing in a distributing fund. This move would necessitate the payment of taxes on all gains at once. Thus, accumulating funds can still be beneficial in generating passive income. By selling units piece by piece.
