Should you invest in investment trusts?

Investment trusts can be a low-cost way to invest in the stock market and get instant diversification but it’s important to understand the risks. 

Although investment trusts work in a similar way to unit trusts, in-so-far as they let you invest in a basket of shares that is managed by a fund manager, they are subject to different rules and present different risks to novice investors.

Work out whether they are the right investment for you with our guide.

Is an investment trust right for you?

Before you invest in any investment trust, it’s important to answer the following questions: 

• Are you willing to risk your investment dropping in value?

• Are you looking to invest for a period of five years or more? 

• Do you understand how investment trusts work and how they differ to other pooled investments like unit trusts which might better suit your needs?

If you answer no to any of the questions above, it won’t make sense to invest in an investment trust.

It is also recommended that you have enough savings in an easy access account so that you don’t need to cash in your investment if you face an unexpected bill.  Likewise it doesn’t normally make sense to invest if you have any debts (aside from your mortgage) to repay.

If you will need your money in the short term or are unhappy with putting your money at risk, then an investment trust is not for you.

How to pick the right investment trust

Here are four things you should do before choosing an investment trust:

Look at where they invest

Each investment trust will vary in terms of where it invests. This could be in terms of asset class, geographical region or company type.

For example: 'Investment trust 1' may only invest in the Asian smaller companies, while 'Investment trust 2' may only specialise in the European property market. ‘Investment 3’ might offer a broad spread of global shares in leading companies.

Look at past performance

Lots of people will pick an investment simply because it is on a good run. However, just because a trust performs well in one year, there are no guarantees that performance will be repeated. 

Instead look at how a trust has performed over longer time frames. A consistent record of above average returns could be an indication that a fund is well managed.

What are absolute returns?

Absolute returns show you how much an investment has grown over a set period; for example, if you invested £1,000 and after two years it was worth £1,200, the absolute return would be 20%.

The danger with using absolute returns is that they fail to show whether an investment trust has fallen in value in any one year, for example:

£1,000 could double in value to £2,000 in year one, but then fall by 50% in year two to £1,500 and appear like it has had an absolute return of 50% over the two years.

What are annualised returns?

They are the standard way to show how an investment trust has performed over a number of years.

The annualised return, gives you an average of how much it has gained per year, taking into account that the balance would increase each year by the amount of income it had earned (compounding returns).

In the same case above, the annualised return is 9.54%, meaning that if you had put your £1,000 in an investment earning 9.54% with compound interest; it would be worth £1,200 after two years.

Check out the fund manager

The fund manager determines where your money is invested, so this is someone you need to have faith in.

You can check fund managers’ performance over three to 10 years online on the TrustNet website.

Top tip: Check how long the fund manager has been in his or her current role - if they only joined a few months ago performance figures will be less useful. TrustNet website

The trust’s attitude to risk

Each investment trust will have a different approach to risk. Look at the trust’s factsheet to find out more. Some will look to really grow investor’s capital for example, and take greater risks than one that only seeks to protect it.

As a guide, trusts that invest in developed economies are lower risk than those investing in emerging markets. Smaller companies are also riskier than bigger, more established businesses.

Some investment trusts use 'gearing' to borrow money for leverage and to chase bigger returns. This can increase their profits when things go well but also makes them riskier because when things go wrong the losses are increased too.

You can find out more about gearing in our What is an investment trust? guide.

What do you need to buy shares in an investment trust?

You can buy shares in investment trusts with an online investment platform or by consulting a financial adviser. Each approach has its advantages and disadvantages:

Investment platform

Independent financial advisor

What is an investment limit?

Some investment trusts put limits on how much you can invest, either by stipulating a minimum or maximum investment deposit.

How can you monitor investment trust performance?

Performance figures for most investment trusts are published on a daily basis. Some will report live trading figures online so you can track how they perform in real time.

One of the key figures is the NAV (Net Asset Value); this is the value of all of an investment trust's assets per share.

The easiest place to track your investments is likely to be online through:

• your investment platform

• your investment trust's website

• third-party investment tracking websites

Hargreaves Lansdown website

How do I sell my shares in an investment trust?

You can sell your shares through the same investment platform you purchased them with, or if you purchased them through an adviser by instructing them to sell them for you.

If you manage your investment trust shares online, you can log into your account and select which investment to sell.

Some accounts may charge an exit fee, but many online accounts will let you sell free of charge.