What is a unit trust?
A unit trust is an open-ended grouped investment product, which means there is no limit to how many people can invest in it or how much can be invested. You buy units with the investment you make in a unit trust.
How does a unit trust work?
It works by pooling your money with other investors into a single fund, which is managed by a fund manager.
Your investment would not be an individual account, but part of a larger investment vehicle.
The fund manager uses the unit trust fund to invest in asset classes through a variety of securities.
Not all securities have the same level of risk, so make sure you are happy with the risk involved with your chosen unit trust.
What are securities?
Securities are the type of financial instrument held in a unit trust, for example, shares, bonds or gilts.
Where do unit trusts invest?
The fund manager will use the unit trust fund to invest in various securities within a specific or selection of asset classes.
Each investment can be further categorised into an investment region, asset classes and industry types. Just some of the different types include:
Asset class: e.g. equity, allocation, fixed Income and property
Investment region: e.g. global emerging markets, UK, Japan and US
Industry sector: e.g. energy, real estate, utilities and healthcare
By investing in a range of different asset classes, investment regions and industry sectors fund managers can diversify where your money is held to try and reduce risk.
You can visit the Hargreaves Lansdown website to find a list of the various types of unit trusts.
How does a unit trust make you money?
You make money by selling your units at a higher price than you originally bought them for.
What is a unit?
When you invest in a unit trust you are buying units in the trust with other investors. Each unit has an individual price called the Net Asset Value (NAV). More units are created to meet your demands, so there is no limit to how many units are created in a single unit trust.
The NAV reflects the value of the overall unit trust's assets, i.e. the investments the fund manager has made with the fund.
This is how the NAV is calculated:
Unit trust assets are worth £100,000
There are 50,000 units already in issue
To find out the NAV, you divide the value of the assets by the number of units already in use, so 100,000/50,000 = 2
This means that the NAV is £2.
The NAV does not represent the price you will pay for a unit in a unit trust. The price of a unit will be affected by administration costs, such as the initial charge.
When should you sell your units?
The amount which you buy or sell units is calculated using a bid-offer spread.
The way a bid-offer spread is calculated differs between fund managers. It represents the difference between how much you buy and sell a unit for.
For example: Offer price (buy) = £2.10 - NAV = £2 - Bid price (sell) = £1.90
If you buy a unit at the offer price of £2.10, you need to wait until the bid price is higher; otherwise you stand to lose money.
For this reason alone, a unit trust is not a short term investment, it can take time for the unit 'sell price' to outperform the original price you bought them for.
How else can you get a return on your investment?
This depends on whether your unit trust is making money or not and the unit type you invest in, such as:
Income units are labelled as 'inc', and accumulation units are labelled as 'acc'.
Income units: Investing in income units means you receive a pay-out up to several times a year*.
Accumulation units: Investing in accumulation units means any income will be reinvested in addition to your existing units*.
If you decide to sell your units you may be liable for Capital Gains Tax - visit the GOV.UK website for more information.
What are the fees for investing in a unit trust?
There are a number of charges to look out for when investing in unit trusts, these include:
Brokerage fees - This differs from broker to broker
Annual management charge (AMC) - This can be between 0.5 - 2%, and pays for the management of the unit trust
Initial charge - This charge can be 3-5% of your deposit and only applies if you choose to invest without seeking advice. This can be avoided by investing through a broker. Initial charges are sometimes replaced with exit fees instead.
How can you invest in a unit trust?
Broker - Discuss your unit trust needs with a broker to find a unit trust that matches the level of risk you are prepared to take.
Direct from fund management company - You can apply directly with a fund management company, like Hargreaves Lansdown, who will take you through the application process.
Independent financial advisor (IFA) - Seek independent advice from an IFA for an unbiased discussion on the type of unit trust you should invest in.
Investing in a unit trust through a broker can save you money on fees compared to investing directly.