The choice between accumulating and distributing funds is one of the most important choices you will make when picking a specific ETF. It will narrow down the amount of funds to choose from, and it will affect your returns as well as your tax-related bureaucracy.
A distributing fund is a fund that will periodically, usually quarterly, distribute dividends to its investors. This is the archetypical type of fund. Accumulating funds are a more recent phenomenon and only available for European investors.
An accumulating fund is a fund that reinvests the investor’s dividends within the fund. In this case, even though the investor keeps the same amount of shares within the fund, those shares are worth more.
The following aspects are important to consider when deciding between distributing and accumulating funds (ordered by importance).
Tax treatment of both types of funds
Usually countries charge a dividends tax whenever dividends are distributed and a capital gains tax whenever a stock is sold. In these countries, an investor of an accumulating fund only has to pay capital gains tax when the fund is sold. Therefore, more capital would be invested in the accumulating fund, leading to greater compound effects and bigger returns than a comparable distributing fund which would get its dividends taxed.
Not all countries provide this tax benefit to accumulating funds. The UK is a notable example of that. Belgium is an example of a country where bond accumulating funds and equity accumulating funds are taxed differently. Germany recently changed its taxes so that accumulating/distributing funds pay the same tax rate though there are still some marginal additional compounding effects from holding accumulating funds.
Different countries have different tax practices therefore, it is important you familiarize yourself with the tax system of your fiscal residence.
Depending on the type of fund you hold you may have to do extra work to report your taxes. In the UK if you hold an accumulating fund, you would 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. This is why some people recommend against holding accumulating funds in taxable accounts in the UK.
Different countries have different tax regimes and you need to be familiarized with yours in order to understand how to proceed.
In order to reinvest dividends in distributing funds you may have to pay transaction fees. You don’t have to pay that for accumulating funds since they reinvest the dividends automatically without passing through your (brokerage) account.
This isn’t an issue if you use a fund which charges no transaction fees for buying additional shares. It is a minor issue if you periodically reinvest (e.g. monthly) into the same fund and can just add the dividend amount to your contribution since you were already going to pay fees anyway.
Availability of funds
You may not find an accumulating and a distributing version for all the funds you wish to buy. For example there isn’t an accumulating ETF that tracks the FTSE All World index, only distributing.
When choosing a fund I suggest starting by deciding whether you want need an accumulating or distributing fund. That will significantly narrow down the amount of available options and make it easier to choose one which fits your investment goals.