Unit trusts have been available as an investment since 1965. Many people however are still unsure about them, mainly because they don’t fully understand the nature of how they work. If you are not confident about investing in the stock market directly then a unit trust may be the next best option.
So what is a unit trust?
Basically it is formed from a large group of investors who pool their money in order to get a spread of professionally managed investments. The average investor does not usually have sufficient money to buy a mix of quality shares (and a range of shares is important to reduce risk). Having a diversified portfolio means that if one share is down the others may be up, therefore stabilising the portfolio. Via a unit trust, an investor can own part of a diversified, blue –chip (a high quality stock with a good track record of consistent earnings) portfolio by investing a modest amount of money. This fund is managed by a fund manager within a company.
How Does a Unit Trust work?
The pool of money is then divided into identical units, each unit containing the same proportion of the assets in the fund. Funds set a minimum investment amount – investors can choose to invest a lump sum or a monthly debit order. Lump sums typically start at R2 000 and minimum monthly debit orders at R500 a month. Investors share in the fund’s gains, losses, income and expenses on a proportional basis.
Unit trust management companies are required to operate their investments within certain requirements or mandates, laid down by the Association of Unit Trusts (AUT) and the Financial Services Board (FSB). The primary purpose of these mandate requirements is to protect the investments of the unit trust holders.
For the past 40 years, unit trusts have provided small investors with a way to participate in the stock and bond markets. The founding fathers of the unit trust industry were mindful of their primary obligation: the protection of small investors. And their groundwork has paid off; there have been no major scandals in the unit trust industry.
The fee for investing in unit trusts is about 5% of your total investment. There are over 800 unit trusts to choose from so you need to learn about how to pick the right ones. A good financial adviser should be able to help you but it is still better to know what to look for. The theories around unit trust selection are becoming almost as varied as the unit trusts themselves.
If you want to invest in unit trusts you should do the following.
- Make an appointment with your financial adviser with the sole purpose of gleaning information about how your investments should be structured and to see where a unit trust could fit in.
- You should split your money equally between five unit trusts that have clearly different objectives. (For example value 20%, growth 20%, world-wide 20%, foreign 20% and gilts 20%.) Gilts are government or quasi-government debt instruments, basically an IOU. Each Gilt has a fixed redemption rate (when the money will be repaid), interest rate and face value (the price for which the government sold it for in the first place). The Gilts are sold and repaid by the issuing authority at their face value – known as “par” value. During this period, the holder receives a fixed rate of interest (say 10%). This interest rate is sometimes called the “coupon”. Obviously, Gilts are secure because they are underwritten by the government. Therefore, there is almost no risk that debt will not be repaid.
- You should review their performance twice a year. Studies have shown that the highest performing funds will attract so much new money from eager investors that they will become too large to continue beating the averages. This means that a top-performing fund will usually do well for three to five years than slip back to average or below average returns. So you must be prepared to switch funds from time to time.
- House your portfolio in a single account via a linked product administrator. A linked product administrator offers a suite of funds under one umbrella so that you can switch between funds easily with minimum cots.
- It is also important to know who is managing the fund. When the managers are doing well stick with them. If you read that the fund manager has left the fund you are invested in to join another company, pay close attention and get ready to move out of that fund.
Investing in unit trusts is a medium to long-term commitment. You should invest only if you are prepared to leave your money there for three to five years.