Distributing or Accumulating ETFs?

Distributing or Accumulating ETFs?

distributing vs accumulating ETF share classes

Let’s take an example that often comes up in comments from my readers. A popular ETF, the Vanguard FTSE All-World UCITS, that has two share classes:

  • Distributing Dividends Share Class (VWRL)
  • Accumulating or Reinvesting Dividends Share Class (VWRA, VWCE or VWRP, depending on the exchange)

Which one is more beneficial for a Long Term Investor? 

Choosing a distributing vs accumulating Share Class comes down to determining (i) whether you are still saving for retirement (ii) your country dividend tax treatment (iii) broker transaction costs (iv) convenience

It’s one of those European ETF Investing quirks, since US fund regulations require a US domiciled mutual fund or ETF to distribute at least 90% of its income to shareholders.

US Investors don’t face this issue – another fun part of being a European Investor!

What are Distributing and Accumulating Share Classes?

Reinvested Dividends - a money making machine!
rolling snowball accumulating etfs

Distributing share classes pay dividends from the income of the underlying shares, so that you can fund your lifestyle (or get that new bike!) 

Accumulating share classes reinvest all income into new shares increasing your wealth exponentially over time – exactly like a rolling snowball! 

But hang on, there is more to it than that, especially if you haven’t retired yet (since you can also manually reinvest dividends, as American Investors do). 

Hopefully, this Q&A can  help!

What are the selection criteria?

Accumulating vs. Distributing - Decision Tree
tax treatment for european etfs distributing vs accumulating etf shares classes decision tree

Are Accumulating share classes more tax efficient?

The key aspect in Accumulating vs Distributing Share Class selection relates to taxes. 

In Europe, it is generally beneficial to choose an Accumulating Share Class over a Distributing Share Class  given a that dividends are taxed when paid, with some exceptions e.g. the UK or Switzerland where this choice is tax-neutral 

The table below summarizes the current tax treatment in Europe 

tax treatment for european etfs distributing vs accumulating index funds - UK germany switzerland belgium portufal italy france ireland poland

Delayed taxation (that will come in form of Capital Gain Tax at moment of sale), provides for compounding that will have a significant advantage over time:

  • Countries including Belgium, Portugal, Spain, Italy, France, Poland, Czechia, or Slovenia tax capital gains only at moment of sale. Accumulating share classes have a tax advantage over Distributing share classes since dividends are not taxed when reinvested.
  • Certain countries including the UK (with a concept of Excess Reportable Income) or Switzerland have a deemed tax. The choice of accumulating vs distributing share class is tax-neutral. You will have to track the dividends that were reinvested and get taxed on them annually (see Convenience section below). ETF providers have to comply with these regulations and you will get a multiplier to calculate the exact amount.
  • Other countries like Austria have partial taxation of reinvested dividends that may provide benefit to Accumulating Share classes. 
  • Ireland, the Netherlands and Germany are special cases. In Ireland, Investors may still achieve higher returns by using Accumulating Share Classes. Germany is probably the most cumbersome case where distributing share classes can provide you with marginal benefits given the tax free allowance but creates an additional admin burden. Convenience may sometimes play a bigger role in this trade-off.
This analysis should only be a starting point. Remember that taxes are individual. The above also does not include tax wrappers or annual tax allowances that you may have and could impact the choice.

Also, don’t over-engineer tax optimization. If you are long term investor the rules will change and there will always be an element of uncertainty. If you are one of those borderline cases (UK, Germany, Switzerland or the Netherlands) convenience is a major factor, too.

Are Accumulating Share Classes more cost efficient?

Outside of Tax considerations, an investor who always reinvests dividend income gains a modest but clear advantage from accumulating ETFs, because they also avoid the trading cost of reinvesting. 

Accumulating funds are useful for long term buy and hold investments during the ‘accumulation’ phase of investing.

If for any reason you decide to choose a Distributing Share Class you can still optimize the transaction cost related aspect of reinvesting. Some brokers may not charge explicit fees (you still need to check bid/ask spreads for your ETF) and if you are saving for retirement you may be regularly injecting cash/rebalancing anyway, in which case you can add dividends on a periodic basis.

When are distributing share classes more cost efficient?

In most cases, overall transaction costs are lower for accumulating share classes. However, if you already reached your investment goal (e.g. FIRE) selling shares may involve extra costs while distributing share classes will provide you with income you need, more cost-efficiently to fund your new lifestyle!

Are Accumulating Share Classes more convenient?

Yes, in most cases Accumulating Share Classes are more convenient – reinvesting creates some burden and potential additional transaction costs. However, there are exceptions. Tax management for Accumulating Share Classes can be more cumbersome if you are e.g. in the UK or Switzerland. It can be less problematic in Germany.

In countries like the UK the implication is twofold, (i) need to account for dividends for tax purposes, on annually basis, even when they are not paid and (ii) you would also have to record how many units were reinvested throughout the lifetime of your holding in order to avoid being double taxed when paying capital gains tax. 

In Germany, tax optimization involves allocating at least some part to the distributing shares classes to benefit from tax free allowance. However, consider the overall benefit vs. additional admin work and transaction costs. 

What should NOT be a consideration

Withholding taxes and ETFs’ on-going fees should, generally, not impact the choice of Accumulating vs Distributing Share Class. 

But, of course ETF share class distribution policy is not the only criterion to take into account. There are other considerations, that I have analyzed (some of them, like costs, are arguably more important)

Are Withholding Taxes important in Accumulating vs Distributing selection?

A withholding tax is a tax on money that leaves a certain country. In many countries, tax services are withholding dividends. It is the case in the United States, the country where most of the world stock market value is. 

The IRS withholds 15% for U.S. citizens and 30% for non-U.S. citizens. There are exceptions for citizens of a countries where domiciled Funds have a beneficial tax treaty with the U.S (e.g. Ireland, which a lot of European Investors use or the Netherlands).

While Fund Domicile is an important ETF selection criterion by itself, it does not play any role in the Accumulating vs. Distributing share class selection.

Remember, this tax is upstream at the company level, e.g. Goldman Sachs paying dividends to an Irish ETF. What the ETF does with the money (reinvest or distribute) doesn’t matter from withholding tax perspective. 

Independently of this ETF selection criterion, if you want to understand more why Fund Domicile matters click here.

Are Distributing share classes more expensive than Accumulating?

By itself, ETF Fees are very important. Even more important is the Tracking Difference. You should know how to select the cheapest ETF to increase your long term returns!

However, Distributing and Accumulating share classes should have exactly the same TER/OCF, e.g. all Vanguard or Xtrackers UCITS ETFs have the same TER for Accumulating and Distributing Share Classes

If the Total Expense Ratio you are seeing on a distributing and accumulating funds is different there almost always may be more fundamental reason(s) to it. Always investigate why it’s the case, it can be due e.g.:

  • Being a Physical vs Synthetic ETF 
  • Currency hedging (although these have fees increasingly aligned with non-hedged these days)
  •  Fund Domicile 
  • or… being part of rare iShares CORE products
Even Google's algorithm is fooled!

 

BlackRock is the exception not the rule. And the exception only applies for isolated iShares cases.

The story starts sometime in 2012, a couple of years after Barclays had to sell to BlackRock its jewel crown (iShares) in the middle of the Global Financial Crisis. 

At that point given the competition from cheaper Vanguard’s ETFs BlackRock have expanded their iShares Range. To compete with Vanguard it launched cheaper products aka ‘CORE’ ETFs.

The effect of this is, that you can still see rare legacy BlackRock ‘non-core’ funds that are more expensive than CORE ETFs. The CORE products were initially designed for Long Term Investors. 

E.g.  iShares IWRD and SWDA funds are often compared and a popular misconception amongst some Boglehead bloggers is that they are the same Fund since they follow the same benchmark:

  • iShares Core MSCI World UCITS ETF (Accumulating) has a TER of 0.2%
  • iShares MSCI World UCITS ETF (Distributing) is more expensive with a TER of 0.5%

The accumulating one is generally cheaper (you can guess who’s the potential Investor!)

However, if you have a deeper look at both products you will realize they are not different share classes of the same ETF but two different Funds. 

They could, in theory change their characteristics and not be aligned. Today, they mostly are (same replication strategy, very similar number of holdings, same return from Securities Lending)

Example of two similar UCITS ETFs (in USD) are highlighted in bold. And yes – for UK Investors Distributing ETFs imply less paperwork!

 

Example of iShares Core vs. Non-Core ETFs

And they are also managed by the same team. 

As it happens, I know quite well the portfolio manager who at one point was running $100bn of these ETFs at BlackRock including the two above, who confirmed that:

This only applies to quite rare BlackRock ETFs – most iShares still follow the rule that TER/OCF is the same for Accumulating and Distributing Classes. 

Another example worth knowing was iShares MSCI Emerging Market ETF (IEEM) that had a fee of 0.75% vs. the ‘Bogleheads’ iShares CORE MSCI Emerging Markets IMI (EIMI) with 0.18%. 

But, this is no longer the case! It was already brought in line and both have now the same 0.18% fee (albeit slightly different benchmark)

Expect the remaining few discrepancies in fees disappear quite quickly (or funds will have different characteristics) as Asset Managers will need to demonstrate that they provide value for money. 

How do I compare Distributing vs Accumulating ETF Performance?

Factsheets for Vanguard FTSE All-World UCITS ETF (Distributing vs Accumulating Share Classes)
vanguard vwrl vwrd vgwl factsheet

Here are some popular misconceptions, that I’ve seen from my readers asking about VRWL vs VWRA:

  • As we know, these are not Funds managed in a different way. The underlying assets are the same and the only difference is the dividend treatment (reflected by having different share classes)
  • Asset Managers like BlackRock, Vanguard or DWS are using scale in the ETF business (that allows them to bring fees down). They would have the exact same team responsible for managing these assets
  • Look at the Factsheets above – while the inception date for Share Classes is different, and the accumulating share is more recent, the total assets under management for the Fund are exactly the same (they can be separated, and some providers will give you the breakdown)
  • Distributing share classes do not take the dividends from the underlying companies and pay them to investors directly. There can be, and often is, a mismatch in dates ranging from days to months between when the underlying companies are paying dividends and when the distributing Fund pays that income to its Investors
  • That’s why in practice, even if you invest in a distributing Share Class, the Asset Manager reinvests all dividends and then sells a portion of the underlying companies’ shares to meet the dividend distribution requirement (only for the Distributing Share Class)

Should distributing and accumulating share classes for the same ETF have the same performance?

Performance of Distributing vs Accumulating Share Classes

As you can see from the Performance Analytics above, both VRWL and VWRA have the exact same annual return since the provider is using a consistent methodology. 

Unless there are methodological differences in the way returns are calculated, their performance should be exactly the same

Notice, that both share classes will use the same benchmark that is a Total Net Return Index (in this case, FTSE All World Net Tax Total Return Index):

  • In order, for the distributing class to be comparable to the benchmark, performance analytics must be adjusted to reflect it – “as if dividends were reinvested”
  • For both classes a standard Withholding tax rate is also applied

Can distributing and accumulating share classes have different performance?

No, if they belong to the same Fund.

But remember, each ETF website can calculate the performance in a different way. 

A Total Return approach should in theory yield the same return for both share classes but an assumption can be made on the dividend tax and that’s why it may create the appearance that results are different

Can I compare two ETFs with different distribution policies?

Comparing two different funds can quickly become complicated if one has a distributing and the other an accumulating share class. 

The easiest way is to compare the same share classes on a Total Return basis (re-invested dividends). 

Otherwise, you may face issues with the calculation. 

E.g. a popular comparison of two funds is Vanguard VWRL vs iShares IWDA, both very large and established ETFs:

  • VWRL Tracks all countries and all companies (excluding small caps) – it is a distributing fund
  • IWDA Tracks only developed countries and all companies (excluding small caps) – it is an accumulating fund

Note, that it’s not entirely appropriate to compare them even though they are some of the most popular options since the Vanguard Funds tracks Developed and Emerging Markets vs iShares only the Developed Markets – so you need to add an Emerging Market ETF to that mix e.g. EMIM ETF. 

Even then, there will be differences in approaches since EMIM includes Emerging Markets’ Small Caps. To know more about which International Benchmarks to track to avoid overlap but include maximum diversification read my guide to International ETFs

I have listed some issues if you want to compare ETFs with different distribution politics. But, I’d prefer comparing Vanguard’s newly launched VWRA vs iShares IWDA + EMIM

 

These are just some of the things to keep in mind when comparing share classes of two ETFs with different distribution policies

What else should I know before buying an ETF?

Click on the picture above to read more about all aspects of European Index Fund Selection, including the most important – ETF Costs!

Good Luck and keep’em* rolling !

(* Wheels & those Dividends – automatically or manually)

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Raph

 

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Jack
Jack
1 day ago

Hi Raph, Great stuff as always! Regarding my previous comment, I think the issue arises from my broker and something I need to internally investigate as my returns for VWRP are noticeably lower than VWRL for the exact same time period and funding (despite receiving the same funding at the same time). It’s all good so far; but something I need to keep an eye out for in a few years’ time. If you’re taking requests for posts/content; I would really appreciate something on the ‘Core and Satellite model’ of investing (ie 90% in a core diverse ETF and 10%… Read more »