In my beginner’s guide to ETFs, I mentioned that there were 2 types of ETFs – Accumulating and Distributing – which differ in terms of how they deal with dividends.
However, I didn’t talk about what these differences mean to us as investors and how they may affect our investment returns.
In this post, I’ll discuss some of these implications.
An Accumulating (Acc) ETF is an ETF that doesn’t pay out any dividends received from its underlying holdings to investors.
Instead, it reinvests these dividends into its portfolio to increase the Net Asset Value (NAV) of the ETF.
As a result, each share of the ETF will now be worth more than before and this translates into paper gains for investors.
A Distributing (Dist) ETF is an ETF that pays out the dividends it receives from its underlying holdings to investors.
Investors will receive dividends as cash in their brokerage account and this translates into realised gains for investors.
In A Perfect World…
Imagine a world where there are no costs involved in buying/selling investments or receiving dividends, and where fractional shares are allowed.
Imagine also that there exist 2 ETFs that are exactly identical to each other with the sole exception that one is Acc while the other is Dist.
In this world, investors would be indifferent between holding the Acc and Dist ETF as long as all dividends received from the Dist ETF are reinvested.
Bogleheads illustrated the comparison of this idealistic case here, which you can check out to see the numbers.
But even without seeing the numbers, this idealistic scenario makes sense.
With no money being lost to fees or taxes, Acc and Dist ETFs become one and the same as long as Dist ETF investors reinvest all of their dividends – because that is exactly what Acc ETFs are designed to do.
Unfortunately, fees and taxes are rampant in the world of investing.
Thus, choosing to invest between Acc or Dist ETFs will have implications on your investment returns.
1: Dividend Withholding Tax
Dividend withholding tax (WHT) applies when the payer (company) and payee (investor) of the dividends are in different countries.
The WHT rate varies depending on the countries of both the payer and the payee.
Consider a scenario where there are 2 equivalent ETFs, 1 Acc and 1 Dist, domiciled in a country where WHT applies to Singapore, such as China.
When the Dist ETF pays out its dividends, some of it will be lost due to the WHT. As a result, investors are only able to reinvest a fraction of the total dividends received by the ETF.
Meanwhile, the Acc ETF is able to reinvest the full amount of its dividends since WHT will not be applicable when dividends are not paid out to investors.
In this case, investing in the Acc ETF is more cost-efficient than investing in the Dist ETF.
However, if both the Acc and Dist ETFs are domiciled in a country where there is no WHT relevant to Singapore, like Ireland, then investors would be indifferent between either ETF.
2: Dividend Handling Fee
Depending on the brokerage you are using, you may be charged a dividend handling fee.
As its name suggests, it is a fee that applies for processing dividend payouts to investors.
Similar to the WHT, this fee will essentially eat away at the dividends that investors actually receive, since a portion of it will go towards paying this fee.
If your broker charges such a fee, then, as before, an Acc ETF will be more cost-efficient than a Dist ETF.
Fortunately, most brokers available to Singapore investors don’t charge such a fee.
To my knowledge, the only brokers that charge this fee are POEMS and FSMOne.
So, for the most part, it should be easy to avoid paying this fee.
But it’s not to say that other brokers won’t adopt this fee in the future, so it’s something worth being aware of and taking note of.
3: Trading Fees
Depending on what you decide to do with the dividends you receive from your investments, trading fees can be another factor that affects your investment returns.
Consequently, what you do with your dividends likely depends on the phase of life you’re currently in.
Wealth Accumulation Phase
This is the phase where you’re trying to build up your investment portfolio, and your focus is on growth.
In this case, it’s likely that you wish to reinvest all the dividends that you receive so that you can maximise the amount of money you have that is working for you.
If you’re invested in Dist ETFs, since all dividends are paid to you in cash, if you wish to reinvest them, you’ll have to do it yourself – during which, you’ll incur trading fees.
On the other hand, if you’re invested in Acc ETFs, all dividends received by the ETF are automatically reinvested into itself, so you don’t have to make any new investments yourself, and you’re able to effectively bypass any trading fees.
Thus, during this phase, it’s more cost-effective to invest in Acc ETFs as compared to Dist ETFs.
Wealth Enjoyment Phase
I like to think of this phase as one where you’re enjoying the fruits of your labour.
After having amassed sufficient wealth, you’re tapping on a small portion of it to sustain or supplement your lifestyle and enjoy life.
During this phase, you’re looking to utilise your investment returns.
If you’re invested in Acc ETFs, the only way for you to do so is to sell some shares for cash, which again, will incur trading fees.
Meanwhile, if you’re invested in Dist ETFs, you’ll be able to tap on your investment returns whenever the ETFs pay out dividends.
If the dividends you receive are insufficient, you can then sell some shares for cash in order to make up the amount of cash that you need.
Since you’ve already received some cash from dividends, the value of shares you’ll need to sell will be less if you’re invested in Dist ETFs as compared to Acc ETFs, and thus, the trading fees you’ll incur will also be lower.
Assuming that no/minimal WHT and dividend handling fees are applicable, it makes sense that owning Dist ETFs is more cost-effective than Acc ETFs during this phase.
Acc > Dist?
Based on the perceived advantages of Acc ETFs, it may seem that they are almost always preferred over their Dist counterparts.
However, that may not be the case.
For one, the expense ratios of the Acc and Dist ETF counterparts may be different, which would result in different investment costs.
From my observations, Acc ETFs tend to have slightly higher expense ratios than their Dist counterparts because they’re newer and have smaller net asset values.
Country & Stock Exchange
Next, the Acc and Dist ETFs may be domiciled in different countries and listed on different stock exchanges.
This results in different rates of WHT and brokerage fees which also contribute to the investment cost.
Lump-sum & DCA
Whether you prefer lump-sum investing or dollar-cost-averaging (DCA) will also affect the decision between Acc or Dist ETFs.
Dist ETFs are unfavourable for lump-sum investing because there may be time lags between the dividend payout and the next lump-sum investment, which results in inefficiency.
Meanwhile, by DCA, you would be indifferent between Acc and Dist ETFs since you can always include any dividend payouts in your next month’s investment.
Thus, it’s clear that the decision between Acc or Dist ETFs isn’t so straightforward in that there isn’t a “one-size-fits-all” guideline.
Instead, more thorough analyses are required before coming to a decision on whether the Acc or Dist ETF of a particular index is more cost-effective.
And this is assuming that an Acc counterpart of the Dist ETF exists in the first place – which isn’t always the case.
Due to the difference in how Acc and Dist ETFs work, it may be possible to leverage this and optimise your investments.
However, there’s no guarantee that this will lead to significantly superior investment performance (if such cases existed, it would probably already be widely discussed).
I think the more important takeaway is to be more aware of how Acc and Dist ETFs can affect our investments and thus be able to pick investments that are in line with our investment approach and goals.
Do you prefer Distributing or Accumulating ETFs? Let me know in the comments below!