When you begin your investment journey, it's daunting to figure out which ETFs to invest in. For Italian investors, there are thousands of ETFs you can invest in. ETFs differ on many things, one of them being how they distribute their dividends: distributing vs accumulating.
Below, we unpack these terms for you. We explain what each means, and what the differences are including taxes, specifically for Italian investors. And most importantly, we answer whether you should invest in distributing or accumulating ETFs.
ETFs: an overview
An ETF (or exchange-traded fund) is a collection of tens, hundreds, or sometimes thousands of stocks or bonds. Investing in ETFs is a lot easier than buying stocks that you have to analyse one by one.
There's a variety of reasons why you should invest in ETFs:
- Diversification at the core: diversification is one of the core tenets of good investing. Through ETFs, you can expose yourself to thousands of companies through just a handful of funds.
- Built for the long-term: investing in ETFs compounds to substantial returns over the long-term and has shown to beat stock picking time and time again. A "simple" globally diversified index like MSCI World has delivered an average annual return of 10.8% since 1979!
- Simple to get started: index investing through ETFs is one of the easiest way to start investing.
- Cheap: with the lack of active management costs, ETFs are a particularly cheap way to invest your savings.
What's a distributing ETF?
Companies share their profits with shareholders through the payout of dividends. For instance, each quarter a company like Apple distributes a dividend to everyone who owns shares in Apple. The dividend is per share, so you earn a higher total dividend the more shares you own.
An ETF that invests in hundreds of stocks receives all these dividends. And if you own that ETF, you are entitled to your share of the dividends. Likewise, bond ETFs receive interest payouts from the underlying bonds.
A distributing ETF will pay out these dividends in cash to you, usually every quarter. You can recognise a distributing ETF as it usually has "Dist" or "Distributing" in its name. Alternatively, you can use a website like justETF to find out if a fund is distributing. There are even ETFs that focus on dividend-paying stocks, the so-called dividend ETFs.
What's an accumulating ETF?
An accumulating ETF directly reinvests the dividends into the fund for you. This means that the value of an accumulating ETF will increase faster than its distributing counterpart. So even though you don't get a dividend payout in cash, you still benefit from the dividends.
You recognise an accumulating ETF by "Acc" or "Accumulating" in their name.
Accumulating vs distributing ETF: which one to choose?
Accumulating ETFs tend to be cheaper
In general the annual costs of ETF are similar between accumulating and distributing ETFs. However, as we showed in the example above, the ETFs tracking the same index have different costs. The accumulating ETF (SWDA) is 0.20% and the distributing ETF (IWLE) is 0.30% per year. Distributing ETFs tend to have higher costs due to the management of the fund.
Accumulating ETFs are tax efficient for Italians
Reinvested dividends are not subject to immediate taxation, offering a kind of 'tax suspension' until you sell. This allows your investments to grow more freely and they aren't affected by dividend taxes. This represents a significant advantage for long-term oriented investors, as your assets can continue growing.
In contrast, distributing ETFs periodically pay dividends to investors. These payments are subject to taxes. The rate is currently 26% for Italian investors.
Accumulating funds have a higher return
Investment returns are also better with accumulating ETFs as the money is reinvested automatically for you. You bypass the dividend tax, but also any other fees or taxes you would incur if you were to reinvest the dividends yourself.
The higher returns of accumulating funds are clearly visible in the animation below. It shows the returns over the last 5 years of a distributing and accumulating version of an ETF. The line of the accumulating fund is clearly higher than that of the distributing fund. You can try it out yourself on the justETF website.
Accumulating funds are more in line with a passive approach
You don’t have to worry on how to reinvest the dividends, the fund does it for you. This saves you time, and prevents succumbing to the temptation of trying to time the market with the dividend payouts. By automatically reinvesting the dividends, compounding can really work its magic. This strategy may be unsexy, but we are convinced that good investing is boring!
Young people are better off with accumulating funds
It makes even more sense for young people to invest in accumulating funds. After all, you're likely still in the phase of your life where you're growing your wealth. With accumulating funds, you won't worry about reinvesting the dividends as it's done for you and you can optimally benefit from the effect of compound interest.
Read more on how to build the optimal portfolio of accumulating ETFs.
If you want regular income, choose distributing ETFs
Distributing ETFs stand out for their regular dividends which are usually paid out on a quarterly basis. Dividends appeal to investors seeking regular income from their investments. As an Italian investor, you receive dividends, which offers flexibility. You then choose to reinvest the dividends or use the money for expenses.
Conclusion: we prefer accumulating funds
Unless you have a good reason not to, we suggest buying only accumulating funds, because you won't be taxed immediately on the dividends and it's best for long-term wealth building.
Curvo: an easier way to invest
Choosing between an accumulating or distributing ETF is one of the many questions you should answer when starting to invest. You have to figure out which indexes should be in your investment portfolio, which ETFs to buy, when to buy, understand the tax implications of your decisions, rebalance your investments and make sure they stay in line with your goals and risk tolerance. We built Curvo to take away all these complexities of investing and turn it into a simple process, accessible to anyone.
We understand that it's hard to build the portfolio that's right for you, so creating an account starts with answering a questionnaire on your investment goals and your appetite for risk. You’ll then be assigned the best portfolio of index funds that matches your goals and risk tolerance. Each portfolio is managed by NNEK, a Dutch investment firm licensed by the Dutch regulator (AFM). The portfolios are globally diversified and you'll invest in over 7,500 companies.
When investing through the Curvo app, you get the following benefits:
- Invest in a portfolio tailored to you: based on a questionnaire, the right mix of funds is selected for you that corresponds to your goals and appetite for risk.
- Safety: your investments are managed by NNEK, a Dutch investment firm that is overseen by the Dutch regulator (AFM).
- Set up an automated savings plan: put your savings on autopilot. Choose an amount and it will automatically be invested every single month.
- All your money is invested: in contrast with other providers, your investments work with fractional shares. This means that all your money is put to work. There will never be cash sitting on your account doing nothing.
- No entry or exit fees: there are no transaction fees, entry or withdrawal fees.
Our mission is to improve the financial well-being of our generation by making good investing accessible to all. Learn more about how Curvo works.
Summary
We explained the difference between distributing and accumulating ETFs. We also discussed the advantages of accumulating funds in terms of taxation, less maintenance, and overall better in line with a buy-and-hold strategy. If you want your investments to grow over the long term without spending much time managing them, it's definitely worthwhile to stick to accumulating ETFs.