Family Investment Basics: What are Investment Trusts?

Taking the first plunge into investment waters is a difficult leap to make. There are many places that families can invest money and often those options vary in risk and commitment. Doubtless you’ve heard of vehicles like stocks and bonds, but what about investment trusts?

Investment Trusts Help Diversify Your Investments

Are you familiar with the concept of diversifying your investments? A single stock’s price can fluctuate dramatically in just a single day. These daily ups and downs are the result of a plethora of factors. Some of those factors are directly related to the company, like performance, and some of those factors are completely outside the realm of control for that company, like an economic recession.

Diversification is about spreading out your investments to a large number of companies to offset some of the volatility that is inherent in a single stock. As nice as diversification may sound, average investors would struggle to take advantage of this strategy on their own. The problem for average investors is that they don’t have the time to manage a large portfolio of stock, which is necessary to properly diversify investments. This is where investment trusts come in.

What are Investment Trusts?

Investment trusts aren’t difficult to understand if you can grasp the basic concept of stocks.

To buy stock in hundreds of companies, you’d save up millions of dollars, devise an investment strategy for a winning portfolio and then go to the stock market and purchase and sell stocks. Sounds simple, but that small sentence would involve nearly countless hours of research and management. You’d have to value and appraise the stock of the companies you were purchasing, pay close attention to their performance so that you could sell underperforming or overvalued stock and keep very good records of your trades for tax purposes.

Investment trusts are companies that perform all the functions above. They pool millions of dollars, enact a specific investment strategy and then buy, sell and manage the stocks they purchase. What really makes investment trusts unique is how average investors get involved with these investments.

How Families Can Invest in Investment Trusts

As I mentioned, one function of the investment trust is to pool money to purchase an investment portfolio. To do this, investment trusts are publically traded and raise money from the sale of a limited amount of stock. Thus, families that purchase stock in the investment trust have part ownership of the investment trust’s diversified portfolio.

You don’t need to buy stock in 30 different companies, just stock in the investment trust and you are diversified by the trust’s portfolio.

What are the Most Popular Investment Trusts?

Collectively, investment trusts hold billions in investment assets. In 2011, Alliance Trust Savings published their list of the 20 most popular investment trusts. These investment trusts ranked highest in gross fund inflow.

Investor’s Chronicle reports that the top 5 most popular trusts were:

  1. Alliance Trust Plc
  2. Scottish Mortgage Investment Trust
  3. Edinburgh Investment Trust
  4. Templeton Emerging Markets Investment Trust
  5.  Murray International Trust

What are the Risks of Investment Trusts?

Investment trusts may offer families an easy way to diversify, but they are not risk fee.

Gains in the investment portfolio are reduced by fees charged by fund manager. These fees vary from trust to trust. It is a smart practice to review the fees charged by the manager, the manager’s strategy and history of success before buying into the company. Large fees charged on underperforming trusts can easily erode your investment gains.

Also, investment trusts have the ability to take on debt to purchase stock. This practice is called buying on margin. While buying on margin can help increase returns, it can also be risky in years where the investment trust is struggling. If the investment trust goes bankrupt, you could lose all of your investment.

Make sure you investigate investment trusts fully before buying their stock. Although popular, not everyone will find them a suitable choice for their family’s savings.

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