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Your Investment Options: A Breakdown of Unit Trusts

There are numerous investing options that new investors can choose to grow their wealth. These include stocks, real estate investment trusts (REITs), exchange-traded funds (ETFs) and unit trusts. In this article, I will take a closer look at what is a unit trust, why and when investors should invest in them, and its pros and cons.

What are unit trusts?

Unit trusts invest a pool of money collected from investors in a range of assets. Each unit trust usually has its specific mandate on the kind of assets it invests in. For instance, equity funds invest solely in stocks, while fixed-income funds invest in bonds. There are also mixed funds that invest in both stocks and bonds.

Unit trusts are actively managed funds, which means that fund managers will actively pick and choose the stocks or bonds to invest in. If you invest in unit trusts, your returns will be dependent on the performance of that individual unit trust that you invest in.

Unit trusts can also be classified geographically by their investment mandate. For instance, investors can choose to invest in a Japan equities unit trust that invests primarily in Japanese stocks. Also, some unit trusts may invest solely in particular kinds of stocks such as income stocks or value stocks.

How do you choose a unit trust to invest in?

Once you have decided that unit trusts are a viable option for you, the next step is to choose which one to invest in. If you are looking for stable and consistent income, you should narrow your choices to bond funds. On the other hand, an equity fund has the potential for better returns but also has a higher capital risk. You should also decide what kind of stocks and region you wish to invest in.

Finally, investors should then compare the historical record of the unit trust that fits your initial criteria. The past is not always reflective of the future, but is your best gauge on the ability of the fund manager.

When should you invest in a unit trust?

Unit trusts are suitable for investors with higher risk appetite and who do not have the time to manage their own portfolio.

You can invest in unit trust if you want to have returns better than the corresponding market index. Fund managers will try their utmost to beat the index. However, be warned. Not all unit trusts can beat the market returns. In fact, the majority of unit trusts end up lagging the market.

Advantages of unit trusts:

  • Professionally managed: Fund managers’ bonuses are tied to the performance of the fund and therefore, the managers should have your interests at heart.
  • Diversification: Unlike investing in individual stocks, unit trusts invest in a basket of stocks and/or bonds, thus providing diversification for the investor.

Disadvantages of unit trusts:

  • Losing to the market: Exchange-traded funds (ETFs) track a particular stock index. Unit trusts, on the other hand, are actively managed, and their goal is to try to get better returns than the stock index. Unfortunately, most unit trusts fail to deliver and end up lagging the market due to the high management fees.
  • Capital risk: Like any other investment, your capital is at risk. Unit trusts are also highly volatile, and the value of your investment can change on a daily basis.

The Foolish bottom line

Unit trusts are an option for busy individuals who have little time to manage their own portfolio. They have the potential for higher returns than ETFs, but the majority still tend to lag behind these low-cost ETFs. If you want to invest in unit trusts, it is essential you choose one that is well-managed and with the best chance for market-beating returns. If you are not confident of picking a market-beating unit trust, it is perhaps better off putting your money in a basic low-cost ETF.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Jeremy Chia doesn’t own shares in any companies mentioned.