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I have a query that's been bugging me. I have been investing in the UK stock market + funds for around a year now.

Current Investments
- Retirement Fund
- FTSE index Fund
- Managed Accumulation Fund

My query is, will these investments over a long period of time compound? (monthly investments for around 25 years)

I mean i'm a bit unsure of how the dividend payments work and I am a bit confused with a lot of the terminology used.

As with anything the prices go up and down daily but if I just keep putting in monthly and don't touch the money will the grow exponentially?

Can someone please give a layman's explanation of dividends, accumulation funds, index funds.

I mean if I have been investing for around 12 months, why do I not see any dividend returns?

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  • Thank you very much for your reply. You have explained everything well. My final question is, what type of investments do compound over time?
    – Mr Capital
    Jan 20, 2019 at 11:12

3 Answers 3

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Investments in stocks or investing in funds that invest in stocks don't grow by compounding.

It is true that some stocks distribute dividends, but that doesn't mean that their price is going up. Most of your investment growth is becasue the price of a share of stock increases over time. Don't get me wrong the issuance of dividends is important, but it is not where most of the stock growth comes from.

To be an investment that benefits from compounding the investment must be returning a percentage of growth over a period of time. This generally comes from money in bank accounts, or investing in bonds where buying the bond locks in a stated percentage of interest over the period of the contract.

When people say stocks increase by on average x% a year, that means that going back decades that is true. But it doesn't mean that is going to be true for the companies you are investing in or for this year. In your case the investment might grow 2 or 3 x or even drop this year.

An index fund is just a basket of stocks that are selected becasue they meet a specific criteria. Investing in the index means you are going to get the average return for the index this year with the lower expenses compared to funds that a similar to the index but try to time the market.

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    Well, investments in stocks compound (even dividend-paying stocks if you reinvest the dividend) in the sense that the growth is considered to be roughly constant. A non-compounding investment would just earn a constant amount every period (like bonds).
    – D Stanley
    Jan 19, 2019 at 17:23
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I think your query is related to the difference between funds that distribute dividends and funds that accumulate dividends and avoid paying taxes on the distribution. The latter are not allowed for US Citizens, it would violate IRS regulation***. In Europe it's common to see accumulating funds and that makes sense given their tax regulation. Both funds pay dividends, and if you select automatic reinvestment on your distributing type fund, they are very similar (pre-tax).

*** There are new funds coming out talking about accumulation, but they have a different tax treatment and this makes them very unattractive in taxable accounts and not comparable to the European accumulating type.

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  • Why do you think US mutual funds don't accumulate & re-invest dividends? Mine - both the ones in 401k/IRAs and outside -have been doing so for the past several decades.
    – jamesqf
    Jan 24, 2019 at 18:04
  • @jamesqf They do accumulate. That's what I said that if you reinvest automatically they are very similar pre-tax. The big difference is the tax on dividends or ordinary income.
    – hernanavella
    Jan 24, 2019 at 18:41
  • You wrote "... funds that accumulate dividends. The latter are not allowed for US Citizens, it would violate IRS regulation". Are you perhaps using a technical/accounting definition of accumulate, rather than the ordinary English meaning
    – jamesqf
    Jan 25, 2019 at 6:16
  • @jamesqf I should say accummulate dividends automatically and not pay ordinary income tax.
    – hernanavella
    Jan 25, 2019 at 14:43
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ftse index fund performance

Others answers here are 100% correct.

A concrete example for your case.

I looked up a FTSE index fund performance over the past year. Dividend yield was 4%, but the overall return was -8%.

So the stocks did pay out dividends (which are typically reinvested into the fund). However, the stocks owned by the fund performed poorly this year (for example Lloyd’s and Barclays stocks both dropped more than 20%).

The way to think about it is that the stocks dropped -12%, but they payed out 4% in dividends.

4% - 12% = -8%

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