At Timeline, we construct our model portfolios using only accumulation share classes. Some of our advisers are interested in why we choose accumulation over income units and what benefit this offers their clients. To explain this, we should first nail down what accumulation and income units are.
When a fund is held in income units, it distributes dividends or interest directly to the investor, whereas accumulation units don’t distribute the interest but instead reinvest it back into the fund, thus providing the client with more investment growth through the power of compounding.
Compounding is the ability for investments to generate interest on top of interest. If investment income is reinvested, the client accumulates earnings on their initial capital amount, in addition to the reinvested income.
Over the longer term, portfolios held in accumulation units tend to achieve a much higher portfolio value when compared to their counterpart income units, despite the fund performance remaining aligned.
Whilst it’s a commonly held belief that income units are more suitable for those that require a regular income, research shows that by using accumulation shares the portfolio is provided with the opportunity to grow more, which in turn can bolster its ability to sustain larger and more regular withdrawals.
Much like Timeline’s Tracker 70 strategy, the above analysis assumes a portfolio with a 7% annual return and 12% volatility. The dividend return is set to 5% to compare the growth between the portfolio value plus cumulative income and the portfolio value plus reinvested income.
The above chart clearly demonstrates how the compounding effect of reinvested
income in accumulation units pushes the cumulative return much higher than that of income units over the long term.
There are additional benefits to using accumulation units which should also be considered, for example, the income derived from income units will fluctuate as and when companies decide to adjust the dividend amount. Where distributed income doesn’t meet the client’s spending requirements, withdrawals may still be needed to top up their cash position.
However, in some cases the client may receive a surplus of distributions from income units, meaning the excess is now sitting with limited earning potential. If the client wishes to reinvest this surplus cash, they may very well be charged a fee for doing so.
By using accumulation units and taking income in the form of withdrawals, it allows the client to plan how much income will be needed and when it will be received. This means excess cash is not generated unnecessarily and is instead automatically reinvested into the portfolio at no extra cost. This allows for increased compounding of the capital and interest, making the client’s portfolio more efficient at growing wealth.
It should be noted that changing between accumulation and income units is equivalent to buying and selling funds. This means that unless the platform possesses the ability to class convert, those that hold investments outside of a tax efficient wrapper and wish to keep the underlying funds but change share classes, may trigger a capital gain and generate a capital gains tax.
Timeline believes that class conversions should be available to all, so we continue to lobby platforms for improved functionality but, if a class conversion is not possible, the adviser will need to consider any potential tax implications.
Whilst we are clearly committed to using accumulation units across all our portfolios, we understand that in certain circumstances it may not be possible. For instance, if a client holds a high value GIA in income share classes, that is also accompanied by large unrealised gains, then we may be able to accommodate them by allowing a select strategy to be held in income units. Please note that such allowances are very rare and Timeline will only consider such cases on an individual basis where all other options have been exhausted.
Although advisers should still consider the features of both share classes and what’s most suitable for the end client, the evidence shows that remaining fully invested through accumulation units and taking income in the form of withdrawals, as and when needed, is likely to produce the best outcome for the client. Therefore, Timeline strongly believes in the compounding benefit of using accumulation units.
Disclaimer
Timeline Planning is a product of Timelineapp Tech Limited. Registered in England. RC: 11405676. Timeline Portfolios is part of Timeline Holdings Limited (Company number 13266210) incorporated under the laws of England and Wales, and operates under the wholly owned regulated subsidiary Timeline Portfolios (Company number 11557205), which is authorised and regulated by the Financial Conduct Authority (firm reference number 840807).
This document has been created for information purposes only and has been compiled from sources believed to be reliable. None of Timeline, its directors, officers or employees accepts liability for any loss arising from the use hereof or reliance hereon or for any act or omission by any such person, or makes any representations as to its accuracy and completeness. This document does not constitute an offer or solicitation to invest, it is not advice or a personal recommendation nor does it take into account the particular investment objectives, financial situation or needs of individual clients and it is recommended that you seek advice concerning suitability from your investment adviser.
Investors are warned that past performance is not necessarily a guide to future performance, income is not guaranteed, share prices may go up or down and you may not get back the original capital invested. The value of your investment may also rise or fall due to changes in tax rates and rates of exchange if different to the currency in which you measure your wealth
