"Unit trusts for dummies" is the ninth article in a 12 part series. Also read the rest of the Sensible Investing series:
Unit trusts (or collective investment schemes as they are also called) are actually pretty easy to understand once you realise that they are just a carrying bag for jigsaw puzzle pieces of investments. What started out as a way to cheaply buy into a wide selection of shares by buying units of a share portfolio held in an investment trust has now expanded to include most of the other investment classes.
In the past, investors have purchased unit trusts without quite knowing what it was that they invested in. It was either touted s a lump sum investment into bits of shares, or a monthly contribution to a savings plan that was almost "guaranteed" to perform much better than a bank savings account or even an endowment.
A bit vague, wouldn’t you agree? Luckily, today investors are much more educated and are quite likely to ask: "But what exactly is it that I’m investing in — how does it work?"
How do unit trust investments work?
Investing in shares used to be an expensive exercise because of minimum investment criteria so the average person with a share portfolio usually only held shares in about three to 20 companies. A limited spread of share investments led to the higher risk of poor performance.
A group of investment geniuses out there decided to set up a large share portfolio (these are not your average investors and so could afford to buy lots of shares) and put it into a trust account. They then divided the whole share portfolio into units so that investors could buy units from as little as one unit at a starting cost of R100. Now the general public could buy into a wide spread of stock market shares at a price they could afford. Each unit comprises a fractions of all the shares held. Whereas holding a portfolio of, say, three companies’ shares exposed an investor to each company’s risk (and let’s not forget the possible rewards!), the same rand value invested in a unit trust would be diversified across many more companies thus reducing the risk of any one (or a few) companies taking a dive. With being invested across so many companies, if one goes belly up, there’s a good chance that at the same time another in the portfolio is doing really well.
The other advantage of buying unit trusts over investing directly in shares yourself is that the unit trust fund is set up and run by experts in the field. They do all the buying low and selling high for you, after careful market and company research and analysis.
Is there a charge for that expertise? Well of course! Unit trusts come with all sorts of fees — fund manager fees, administration fees, etc. Those fees are applied if you invest in them yourself directly. Because there are so many funds to choose from (around 150 in the local market alone) you may need help in deciding which one suits your needs and therefore employ the services of an advisor. He will also charge you for that advice, in commission.
So, if you don’t carefully look at all the fees charged on your unit trust investment, the costs could seriously hamper the expected returns. This is always something to consider though. Do you have the time and enough knowledge to skimp on advice fees and do it yourself? Or would you rather pay for a bit of help in deciding which fund/s to choose and then occupy your time and skills elsewhere?
Article continues on page two: the different types of unit trusts...
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