The difference between income funds and accumulation funds is actually pretty straightforward. Each does what it says on the tin, with one 'paying' (income funds) and the other 'growing' (accumulation funds).

However, knowing what each entails and using that knowledge to choose the best investment trust, unit trust or OEIC is another matter entirely.

How do investment funds work?

While the pricing and mechanics of different types of funds vary significantly, they all work on the same broad principles:

  1. Investors buy 'shares' in a fund

  2. Their money is pooled together

  3. The fund uses its pooled capital to invest in specific assets

  4. Investors are rewarded based on the fund's overall performance

The distinction we are making is limited to point 4: how investors are rewarded.

Even a classic income fund that invests in fixed return assets can still be set up for accumulation: it boils down to what the fund does with your profits

So what is the difference between the funds?

Income Funds

Income funds pay any profit to your nominated bank account, whatever their underlying investments. Crucially, this means that you can withdraw the money now as an alternative income.

Typically, income funds buy fixed return assets such and bonds and securities. However, you could choose a fund that invests purely in equity and still use it as an income fund by opting to withdraw your profits.

Accumulation Funds

Accumulation funds on the other hand automatically reinvest your profits to buy more shares in the fund. This means your stake in the fund grows, and your profit should grow exponentially over time as long as the fund performs well.

All investments should be treated as mid to long-term (generally 5 years plus), however as most funds will give you the option to choose between income and accumulation when you first invest you are able to decide whether the investment is totally geared to the future, or if you benefit from any income now.

Are income or accumulation funds safer?

All investments necessarily involve some risk: profit cannot be guaranteed and the value of the fund can go down as well as up. Their intrinsic risk is relatively equal because the safety of your money mostly depends on what the fund invests in.

  • Stocks and shares are generally thought to have greater inherent risk, but even this can be mitigated by investing in a spread of 'safer' businesses and markets.

  • Securities, gilts and corporate bonds are typically thought to be the safest options and will often pay a fixed (albeit, usually lower) return.

Both income and accumulation funds limit your risk by pooling your money with other investors'. This increases their purchasing power so the fund can invest in a wider range of assets - think fewer eggs in one basket.

In a sense, income funds are slightly safer because each withdrawal reduces your exposure. However, withdrawing the account earnings with each round of payments will limit the growth of your overall investment.

Investment Trusts

Investment Trusts are 'closed ended', which means the fund is made up of a finite number of shares whose price is not directly linked with the fund's overall investment; you can potentially buy overpriced or underpriced shares.

This also has implications for the question of Income vs. Accumulation. With a limited number of shares available, they may not offer the facility to automatically reinvest your profit. As such you will need to proactively buy back into the fund if you are in it for accumulation.

Should you choose income or accumulation?

If you need a regular income from your investments then an income fund lets you marry short term benefits of a regular income with some aspects of a longer term investment (the fund's own shares or unit price).

Remember

As long as the fund continues to profit, the value of your individual shares in Unit Trusts or OEICs will grow too, so you could eventually sell them for a profit.

On the other hand, reinvesting your earnings through an accumulation fund means your holding will grow faster and with it your potential for profit over time - assuming the fund performs well.

If it performs badly, even more of your money is invested and subject to stock market risks.

When it comes to deciding whether income or accumulation is the better choice for you, weigh up your short term and longer term needs.

Alternatively, you could explore other investment types, such as premium bonds. Read our guide on how premium bonds work and how they could make you money.

After that you will need to compare investment funds and choose those with underlying investments match both your goals and your attitude to risk.