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Understanding Mutual Funds and Unit Trusts

October 30, 2014 Posted by admin

Understanding Mutual Funds and Unit Trusts

For those who want to get involved in the stock market, but don`t have sufficient funds to make it worthwhile purchasing just one company`s stock, mutual funds, or unit trusts, can be a good option. Many companies allow the purchasing of these on a monthly basis, thus `drip feeding` the purchases over a period of time.

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it on their behalf. The mutual fund will have a fund manager that trades the pooled money on a regular basis. The term mutual funds is used in the United States and Canada. In the UK, Ireland, Australia and some other countries they are known as unit trusts. For our purposes mutual funds and unit trusts have been to mean virtually the same thing, but note there are some differences, which should be checked at the time of any purchase.

Trusts and OEICs provide a mechanism of investing in a broad selection of shares, thus reducing the risks of investing in individual shares. There are thousands of Unit Trusts and hundreds of OEICs to choose from, so it is important to select the right fund to meet your needs.

Unit trusts are open-ended; the fund is equitably divided into units which vary in price in direct proportion to the variation in value of the fund’s net asset value. Each time money is invested new units are created to match the prevailing unit buying price; each time units are redeemed the assets sold match the prevailing unit selling price.

Each Unit Trust has its own investment objective and the fund manager has to invest to achieve this objective. The fund manager will invest the money on behalf of the unit holders (or shareholders). The value of your investment will vary according to the total value of the fund.

The trust manager makes a profit in the difference between the purchase price of the unit or offer price and the sale value of units or the bid price. This difference is known as the bid-offer spread. The bid-offer spread varies from company to company, and even from fund to fund within the same company. Market conditions will often dictate the size of the spread, the lower the spread the better for the investor. Some fees are declared as a percentage of your investment, others are built into the price.

Mutual funds, and unit trusts, can invest in many kinds of securities. The most common are cash instruments, stock, gilts, and bonds, but there are hundreds of sub-categories. Common areas to invest in are stocks in geographical areas, such as North America, Europe, Asia and so on. Or, they can invest in Emerging Markets, New Companies, companies with green credentials, small companies, or the bigger so-called Blue Chip companies etc.

Bond funds can vary according to risk, for example high-yield junk bonds or investment-grade corporate bonds, type of issuers such as government agencies, or corporations, or even the maturity of the bonds as in short or long term.