Thursday, April 24, 2008

Dispelling the myths surrounding unit trust investments

UNIT trust funds are fast becoming the investment of choice for many people nowadays.

The reason for unit trusts popularity is clear: they provide investors with a convenient and efficient means of implementing a sophisticated and diversified equity investment strategy.

However, investing in unit trusts is not a substitute for thorough investment planning.

Any investment you make must suit your overall investment strategy, and also fall within your desired asset allocation (the amount of your assets to be invested in equities, bonds, property and cash).

There are several myths around unit trust funds which have arisen among investors.
Here are six of the more popular myths we need to clarify..

Myth 1: Investing in unit trusts is a strategy in itself
Not at all. Unit trusts are an investment tool, and therefore a means to an end.

Myth 2: A unit trust is a unit trust (that is, they're all the same anyway)
Wrong. First, funds are grouped into categories or sectors according to their broader investment focus.

For example, general equity funds invest across a number of sectors in the stock market, whereas specialist equity funds focus on specifically designated areas of the stock market - such as small market-capitalisation, emerging companies, or predominantly international shares.

Secondly, even within a category or sector, funds vary dramatically as they have different mandates, investment styles and objectives, risk profiles and past performances.

It is therefore extremely important that the unit trust you select matches your own investment objectives and risk profile.

Myth 3: Holding two funds provides automatic diversification benefits
Maybe, but probably not. Different management companies may run similar funds investing in similar shares, thus offering minimal diversification benefits.
The end result could be that you are either over-exposed to a disappointing stock or under-exposed to the top performing stock.

Invariably, impatient investors who have a propensity for switching end up chasing last year's winners.

However, switching may be appropriate where a fund has consistently underperformed over a long period (say two years or more), or where a fund's mandate has changed, or your risk profile or investment objectives have changed and the fund is no longer suitable for your needs.

Evaluate your unit trust funds as a portfolio, therefore, rather than as individual entities.

Myth 4: Cash is a risk-free alternative
Cash is certainly less volatile, but it may not provide the returns required to meet your objectives. And capital appreciation of your unit trusts is tax-free, unlike returns on your cash, which are fully taxable.

Over the longer term, the stock market has outperformed most other forms of investment. Don't rue missing the next bull run. Let time be your hedge against market volatility.

Myth 5: Selecting a unit trust fund can be left to my financial adviser
It can, but only as long as the adviser is fully appraised of your needs and investment objectives.

If so, he or she will be able to select an appropriate fund from a range of options to suit your needs.

The adviser should also recommend changes in your unit trust portfolio as your needs and investment objectives change over time.

Myth 6: Switching unit trusts helps improve returns
Switching between funds incurs costs that could offset any capital appreciation.
Also, it may add risk to your portfolio as you try to time the market or select the next winner. Anyone who believes they can consistently select the next winner just before it zooms to the top is dreaming!