Distributing or reinvesting: where do the dividends go?

Some funds distribute profits, others reinvest them directly. Both can be advantageous. Investors have to decide which option suits them better.

If you want to invest in funds, you usually have to make a decision: Should the money go into a distributing or accumulating fund? With ETFs in particular - funds that track common indices such as the MSCI World - there are usually enough variants for both. The difference lies in how the profits are handled.

The stock corporations whose shares are held in funds pay dividends or, in the case of bond funds, interest to the shareholders. "Investment funds collect these profits," says Thomas Mai from the Bremen consumer advice center. "In the distributing variant, the dividends or interest are then regularly transferred to the investor's account. Accumulating funds reinvest the money," explains Thomas Mai, financial expert at the Bremen Consumer Advice Center.

Because the profits of accumulating funds remain in the fund assets in order to buy new shares, the value of the fund increases. The result can be seen in a direct comparison of the variants. "Accumulating funds have a higher price return than their distributing counterparts," says Mai. "This makes a difference over the years. With accumulating funds, the assets are larger in the end."

Compound interest improves the savings phase

However, investors can also achieve this compound interest effect with distributing funds. To do so, they have to reinvest dividends paid out themselves. "With some banks, automatic reinvestment can be agreed, but savers usually have to take action themselves. Transaction costs may also be incurred when buying new units. This makes it unnecessarily expensive," says Karin Baur, investment expert at Finanztest.

If you don't want to worry too much and want to invest your money for the long term, you should therefore opt for accumulation funds. "This is especially true for younger people. It is important for them to optimize the savings phase."

In some cases, however, the distributing variant can also be a good choice. "If investors need money on a regular basis, it flows automatically through the distributions at no extra cost. Fund units do not have to be sold for this, as would be the case with accumulating funds," says Thomas Letsche, ETF analyst at the JustETF comparison platform. The dividends end up directly in the custody account.

This also has a psychological advantage, says Letsche. "The effect of the investment can be seen immediately through the distributions. This helps motivate some investors."

Pure dividend stocks tend to be at a disadvantage

Many funds distribute the accumulated profits once a year. Some even have two or four dates a year. However, it is not certain how much will be paid out. According to JustETF, ETFs on the well-known MSCI World have an average dividend yield of just under two percent. If you are looking for passive income in order to receive a supplementary pension, for example, you need a large custody account. With the average distribution, 200,000 euros would be enough to receive around 333 euros a month.

There are funds that offer particularly high payouts, so-called dividend ETFs. They invest specifically in companies that have reliably given investors a comparatively good share of profits in the past. However, a high dividend yield should often be treated with caution, explains Letsche.

"This is calculated by dividing the dividends by the price of a fund share. If the performance is poor, i.e. the share price is low, the dividend yield is correspondingly high." And established companies in particular, which no longer tend to grow strongly, often pay high dividends - this has an impact on the share price.

Karin Baur from Finanztest says: "If you want, you can invest in dividend stocks. However, investors have done better in recent years with a broadly diversified portfolio that contains not only value stocks but also growth stocks."

In terms of tax, it makes no difference in the end

Until 2018, the tax rules for distributing and accumulating funds differed. But today, after a reform, this is hardly relevant when making a decision, says Mai. "The tax burden is the same for both. The saver's allowance, which means that part of the profits remain tax-free, can be utilized with both variants."

In the case of accumulating funds, an advance lump sum is calculated each year. The tax liability is usually paid via the settlement account. Investors must therefore make sure to park a buffer there. If you cannot or do not want to do this, you should choose a distributing fund. This is because the taxes are simply deducted from the dividends.

Regardless of which fund an investor chooses, you can't really make any big mistakes with this decision. Moreover, the options are not mutually exclusive. Anyone who has previously saved with accumulating funds can also combine this with a distributing fund. "This can make sense, for example, if the life insurance policy is paid out shortly before retirement. The distributions can then later form part of the supplementary pension," says Baur.

But there is one thing no one should do: Sell the accumulating fund at the start of retirement and invest the money in a distributing fund. Because then all taxes are due at once. Accumulation funds can also be used to generate passive income. By selling the units piece by piece.