What Is a Unit Trust?

A unit trust places your money in the hands of an expert fund manager together with other investors. Here is a guide on what you need to know about unit trusts before you invest.

What is a unit trust?

It is an open-ended grouped investment product, meaning that there is no restriction to how many people can invest in it or the amount of money that can be invested. You purchase units with the investment you make in a unit trust.

How does a unit trust work?

It works by placing your money with other investors into a single fund, which is controlled by a fund manager.

The fund manager then makes use of the unit trust fund to invest in asset classes through various securities.

However, not all securities have the same risk levels, so make sure that you are happy with the risk involved with your selected unit trust.

Where do unit trusts invest?

The fund manager will make use of the unit trust fund to invest in various securities within a specific or selection of classes of assets.

Each investment can be categorised further into an investment region, industry types, and asset classes. Some of the different types include:

  • Investment region: for example, global emerging markets, UK, US, and Japan
  • Asset class: for example, equity, allocation, fixed Income and property
  • Industry sector: for example, real estate, energy, utilities and healthcare

By investing in a range of different investment regions, asset classes, and industry sectors, fund managers can expand where your money is held to try and reduce risk.

How does a unit trust make you money?

You earn money by selling your units at a higher price than you originally purchased them for.

What is a unit?

When you invest in a unit trust, you are purchasing units in the trust with other investors. Every unit has an individual price which is called the Net Asset Value (NAV). More units are created to meet your demands, so there is no restriction to how many units are produced in a single unit trust.

The NAV reflects the value of the overall assets of the unit trust, for example, 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 that you will pay for a unit in a unit trust. The price of a unit is affected by administration costs including the initial charge.

When should you sell your units?

The amount at which you buy or sell units will be calculated using a bid-offer spread.

The way a bid-offer spread is calculated varies between fund managers. It represents the difference between how much you sell and buy a unit for.

For example: Offer price (buy) = £2.10 – NAV = £2 – Bid price (sell) = £1.90

If you purchase a unit at the offer price of £2.10, you must wait until the bid price is higher; otherwise, you risk to lose money.

For this reason alone, a unit trust is not a short-term investment; it can take time for the unit’s ‘sell price’ to outperform the original price that you bought them for.

How else can you get a return on your investment?

This will depend on the unit type you invest in and whether your unit trust is making money or not, such as:

  • Income units: Investing in income units means that you receive a pay-out up to several times per year*.
  • Accumulation units: Investing in accumulation units means that any income will be reinvested in addition to your existing units*.

See also: Should You Invest in a Unit Trust?

You may be liable for Capital Gains Tax if you decide to sell your units – you may visit the GOV.UK website for more information.

What are the fees for investing in a unit trust?

There are some charges to look out for when investing in unit trusts, these include:

  • Annual management charge (AMC): This can be between 0.5 – 2%. It pays for the management of the unit trust.
  • Brokerage fees: This varies from broker to broker.
  • Initial charge: This charge can be around 3-5% of your deposit and only applies if you decide to invest without seeking advice. However, 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: Talk to a broker regarding your unit trust needs to look for a unit trust that matches the level of risk you are prepared to take.
  • Direct from fund management company: You can directly apply with a fund management company, like Hargreaves Lansdown, who will take you through the process of application.
  • Independent financial advisor (IFA): Seek independent advice from an IFA for an unbiased discussion on the kind of unit trust you should invest in.

Investing in a unit trust via a broker can save you money on fees compared to investing directly.

 

What Is an Overdraft?

In layman’s terms, being overdrawn, or getting an overdraft, is when you exceed the amount that you have in your bank account.

Being overdrawn is normal, but picking the wrong current account can mean paying far more than you should in charges when you overdraft.

Types of overdraft

An overdraft is distinguished into two, and the difference between them is fundamental:

Authorised overdraft

Authorised overdrafts are pre-arranged with your bank. If you have an authorised overdraft, this means you have set an overdraft limit for your account. You will typically have to pay a fee or an interest in return for using an overdraft facility, although some banks do give interest-free overdrafts.

Unauthorised overdraft

This is where you have not consented to an overdraft facility with your bank in advance and have spent more money than you possess in your account, or you have used more than your authorised overdraft limit.

Unauthorised overdrafts should be avoided because they are usually subject to fees which can be costly.

Taking advantage of an overdraft

Overdrafts can be a helpful way to loan small amounts of cash for a short period. However, overdraft is not an effective way of borrowing in the long-term, because they almost always come with a higher interest rate than some loans and even some credit cards which are already high.

It can be helpful to have an overdraft facility arranged with your bank even if your current account is constantly on credit.

Having an overdraft can play as a buffer to avoid fees for unauthorised borrowing if you accidentally overspend or find yourself needing a little more fund. Accounts with fee-free overdraft are useful for this type of technique.

What to do if you depend on your overdraft?

If you are constantly overdrawn or regularly go overdrawn without authorisation then you should check to see if you are getting the best deal on your current account, as you could be spending far bigger than you need to in fees or charges.

If you have a large overdraft and you cannot or do not want to shift to an interest-free overdraft account, you could consider switching your overdraft to a less expensive type of loaning.

You could consider getting a personal loan (secured or unsecured loans) at a moderate rate of interest than you are spending on your overdraft.