Accumulating or Distributing ETF: why does it matter for Belgians

Remark: This is only true for personal investments. It might not (always) be accurate for investments via a company set up.

The theoretical background on ETF's

The general consensus within the FIRE movement is to invest in:

Broad diversified ETF's
Denominated in EURO (no exchange fees)
Accumulating ETF's (no taxation on dividends)
Based in Ireland (no source taxation in Ireland)
Full replication or optimized sampling. Synthetic ETF's to be avoided as they introduce additional counterparty risks (through swaps and/or derivatives). https://www.justetf.com/uk/academy/synthetic-replication-of-etfs.html

An ETF is an exchange-traded-fund. You can buy and sell shares of this fund on a stock exchange as you would do with a normal asset (stocks for example). The fund itself buys and owns assets. For example: IWDA (IE00B4L5Y983) tries to follow the MSCI World index and owns 1603 different stocks from 23 developed countries worldwide. The assets that the ETF buys are often called "the underlying shares". If you buy a share of the ETF, you do not become the owner of these underlying assets. You become partial owner of the ETF (which owns the underlying shares).

The value of the ETF is called the Net Asset Value (NAV). It is the cash value of the fund when it would sell all the shares that it owns + it's cash - it's costs/liabilities. NAV per share is how much each ETF investor would get for each ETF share he owns (if the ETF would close down).

The NAV per share is not the same as the ETF share price ! The price of the ETF can deviate from the NAV per share. But if the NAV per share differs to much from the ETF's share price, market arbitrage will kick in. Either people will see that the ETF is being sold at a discount and will start buying. Which drives the ETF price up until it's equal to the NAV. Or authorized participants will create or redeem shares to align the ETF price with the NAV.

A small word about dividends

When a listed company makes money, it can do two things with the earned money. Either they reinvest the money in the company itself. Or they pay out (part) of the money to the owners (investors) of the company. This is called a dividend. Some company's pay dividends. Some do not.

In Belgium, dividends that you receive are taxed 30% (except for two BE-REITS that invest in care properties). There is also a tax break where the first 800 euro (2020) in dividends are not taxed. This is only for normal shares. Dividends from funds or ETF's are always fully taxed.

Side note: two important dates for a dividend are the pay-out date and the ex-dividend date. The pay out date is when the dividend get's paid to the investor. The investor who owned the asset on the ex-dividend date will get the dividend. So if you bought a share 1 day after the ex-dividend date, the previous owner would still get the upcoming dividend.

How does a distributing ETF work?

A distributing ETF would receive and collect all the dividends from the underlying shares. The ETF will then payout that money to it's investors on periodic moments. The NAV of a distributing ETF will drop with an equal amount of money as the ETF paid out.

How does an accumulating ETF work?

An accumulating ETF will also receive and collect all the dividends from the underlying shares. But it will buy additional underlying shares. It's NAV will not drop as the dividends stay in the ETF.

Comparing an accumulating vs a distributing ETF

Simplified example: the ETF price and NAV per share is 50€ for both the accumulating and distributing version of an ETF. It's dividend payout time and all the dividends that the fund received amounts to a total of 5€ per share.

The distributing version will pay out these dividends to the ETF share owners. In the end, the NAV/share will drop with 5€/share as the money has been removed from the ETF and paid to it's investors.

The accumulating version will buy more of the underlying shares. The NAV per share stays 50€ as we do not extract the money from the ETF.

In both cases, the ETF price will align with the NAV/share price thanks to the earlier mentioned market arbitrage. This might happen immediately (a drop when dividends are paid). Or it might take some time. This difference in dividend pay out is why an accumulating version outperforms a distributing over the long term. Because you do not extract money from the ETF.

A distributing ETF will still gain in price as some underlying shares do not pay dividends. And some underlying shares can still gain in price while paying out dividends. But the distributing ETF will gain less than an accumulating.

You can see it in below GIF (source). It's the chart of the distributing version of IWDA where you can see the dividends payout dates of the ETF at the bottom. There is a toggle feature below the chart (left side) where you can switch between "including dividends" or not.

If you include dividends: it's actually just the accumulating version.
If you exclude dividends: it's the distributing version dividends are not reinvested.

Notice the difference in growth when the duration is set to MAX (150% vs 231%).

Why an accumulating ETF is better then a distributing for Belgians

So now you might say:

But wait ! If I reinvest the dividends (from my distributing ETF) myself, I would get the same returns as the accumulating one.

In theory, yes. In practice, no. There are some additional costs which come into play when you buy additional shares yourself:

You always pay 30% tax on the dividends when they get paid out.
You pay the stock transaction tax on the additional shares you buy.
You pay (possibly) a broker's fee.

These are extra costs which you do not have when you use an accumulating ETF, making it cost and tax efficient. Which means higher returns in the end. You also have less work (no need to spend time following up your dividends and buy additional shares). And that's why we like an accumulating ETF better then a distributing.

Summarized

Less costs resulting in a bigger return on your investment.
Less work as you do not need to follow up your dividend taxes.
Less work as you do not need to reinvest your dividends.