Income Focus
When to accumulate and when to generate income: The story of Isabel and Alexander
In our example, software developer Isabel chooses accumulation funds to maximise the long-term value of her investments. But part-time administrator Alexander chooses income funds to supplement his earnings today.
The decision of whether to select an accumulation fund or an income fund depends on an investor’s circumstances. We have created two fictional investors to help investors decide which type of fund is right for them.
Isabel, 35, is a software developer with a higher-than-average income. She owns her home with a mortgage. She and her partner have two children who are both at school.
Alexander, 53, is a part-time administrator. He used to work fulltime but recently reduced his hours so that he can care for his elderly parents. Before going part-time, he worked for many years in public service, which means he is entitled to a good pension when he reaches pensionable age.
Isabel and Alexander: a story of two investors
Isabel invests in accumulation funds. She is able to pay for her present lifestyle out of her salary and wants to maximise the long-term value of her investments to support her family in her retirement.
Isabel knows that, because of the benefits of compounding – in which interest reinvested in the fund earns “interest on interest” – accumulation funds tend to generate a higher final value than income funds. She also knows that her earning power may fluctuate over her career, and she wants to put as much into her funds as she can, while she can. Her investing strategy is focused on the long term.
Alexander has opted for income funds. The benefit for him is being able to top up his part-time earnings with income from his funds, meaning he can continue to pay for his lifestyle while working fewer hours. This, in turn, frees up time to care for his parents.
Alexander knows the final value of his investments is likely to be lower than if he chose an accumulation fund, but he is willing to accept this trade-off because the income he receives from his funds is so valuable to him. He also has the reassurance of knowing that his public service pension will help to support him in retirement.
Alexander’s investing strategy is more focused on the present day than Isabel’s. Although, like her, he has thought about his long-term future, he is using his funds as a tool to meet his immediate needs.
What are income funds? Download our explainer
Choosing a fund is a dynamic process, not just “set and forget”
As the example shows, the question of whether to accumulate or generate income depends on the investor’s financial situation – taking into account their income from employment or other sources, and their outgoings. But, situations can change, which means the choice of fund may need to be reconsidered if the investor enters a new phase of life.
For example, if Alexander’s caring responsibilities were to end, he may decide to return to work full-time. At that point, it may make sense for him to move his investments from income funds to accumulation funds. That way, he could increase the potential final value of his investments by foregoing the income they had provided.
If, on the other hand, Isabel were to suffer a professional setback such as redundancy, she might decide to move her investments from accumulation to income funds. She might find the income provided by the funds to be helpful in bridging a gap in employment.
Seen in this way, the choice between accumulation and income funds is not a matter of “set and forget” but is in fact a dynamic process that should reflect an investor’s changing circumstances.
Do you need the money now or can you afford to wait?
In essence, the choice between accumulation and income is about whether an investor can afford to reinvest the fund’s income, or whether they need it now. This inevitably touches on other questions about a person’s lifestyle, approach to budgeting and employment status – all of which are highly personal. A financial adviser may be able to help investors make the right decisions for them.
In general, we can say that accumulation funds are probably the right choice for someone who wants to maximise the long-term value of an investment. Income funds, however, can be a useful tool in meeting an investor’s day-to-day needs. This may be a matter of necessity, but it can also be a way to add joy to life. By accepting a lower final fund value, the investor gets to enjoy the fruits of their investment here and now.
