DEFINITION of Accumulation
Accumulation has several definitions in the finance world:
- It can refer to an individual investor's cash contributions toward building wealth over a period of time (often for retirement). Many investors go through an accumulation phase in order to create a portfolio of a desired value. During a period of accumulation, the investor often re-invests all dividends and capital gains.
- It can also cover an institutional investor's purchase of a large number of shares (i.e., taking a position) in a public company over an extended period of time.
- It can mean the retention of company profits for reinvestment in business operations (as opposed to the payout of earnings as dividends to shareholders).
BREAKING DOWN Accumulation
In the first definition above, when an individual investor is attempting to build up the value of her portfolio, she is said to be accumulating wealth. Automatic reinvestment of profits over the course of the investment time horizon can significantly boost the pace of accumulation via the benefits of compounding.
For example, suppose an individual deposits $10,000 into an account that pays 6% annual interest. After the first year (compounding period), the total in the account has risen to $10,600. In the second year, the account realizes 6% growth on both the original principal and the $600 of first-year interest, resulting in a second-year gain of $636 and a balance of $11,236. After 10 years, assuming no withdrawals and a steady 6% interest rate, the account would grow to $17,908.48.
In the second definition above, large investors and financial institutions are limited in their ability to move in and out of securities, because they deal with a large volume of shares that has the potential to drive up the price of a security if ordered all at once. To buy their intended number of shares without skewing the market price, institutional investors spread their accumulation of a company's stock over a period of time.
Finally, as opposed to paying dividends to investors, a company can choose instead to accumulate its earnings in order to accelerate their expansion so that down the line it can produce extra value for shareholders.
Accumulation in Annuities
The accumulation phase has an alternate definition with regard to annuities. An annuity is a financial product that pays a fixed stream of payments to an investor. The primary use of this is as an income stream for retirees. Annuities have two main phases: the accumulation phase, during which the investor funds the annuity, and the annuitization phase, after payouts begin.