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How Investment Trusts Differ from Mutual Funds: A Comprehensive Comparison

Moneymagpie Team 2nd Apr 2024 No Comments

Reading Time: 4 minutes

You’re comparing investment trusts to mutual funds, and here’s what sets them apart. Investment trusts are like companies that can borrow to invest aggressively, trading on stock exchanges, which allows their prices to fluctuate based on demand. They might offer you steadier income and the potential for cost savings.

On the other hand, mutual funds spread your money across a wider array of investments for stability, priced daily at their net asset value (NAV), reducing market price volatility.

Each has unique tax implications and fees impacting your returns. Understanding these differences will prep you to make informed decisions that align with your financial goals.

Definition and Basics

An investment trust is a form of collective investment found mainly in the UK. It’s a public limited company (PLC) that pools your money with that of other investors to invest in a wide range of assets.

You’re buying shares in a company that owns investments. The value of these shares fluctuates based on the performance of the underlying assets and the supply and demand for the shares themselves.

On the other hand, mutual funds, widely available globally, also pool money from many investors. However, you’re buying units in the fund, not shares in a company. A fund manager selects and manages the investments. The value of your units rises or falls with the value of the fund’s assets.

Legal Structure

Investment trusts are structured as corporations or public limited companies. This means you’re basically buying shares in a company that invests in other companies. Your stake represents a portion of the trust’s overall assets and performance. This structure allows investment trusts to borrow money to invest, known as gearing, potentially enhancing returns but also increasing risk.

On the other hand, mutual funds are structured as open-ended investments. They’re not companies themselves; instead, they’re a collection of investments managed by a financial institution.

Pricing Mechanisms

You’ll find that investment trusts, being closed-end funds, have a fixed number of shares traded on the stock exchange. Their prices are influenced by supply and demand dynamics, meaning they can trade at a premium or discount to the net asset value (NAV) of their holdings. This fluctuation adds a layer of market risk and opportunity not typically found in mutual funds.

On the other hand, mutual funds are open-end funds, allowing you to buy and sell shares directly with the fund at the end of each trading day at the NAV. This price reflects the total value of the fund’s assets divided by the number of shares outstanding, ensuring that you’re buying in at a value directly tied to the fund’s holdings.

Investment Strategy

Investment trusts often employ a more aggressive strategy, taking advantage of their ability to borrow money to invest, known as gearing. This can amplify returns but also increase risk.

Typically, these trusts might focus on investing in a portfolio of tech companies, which can lead to a more concentrated asset allocation, increasing volatility but also offering the potential for substantial gains.

On the other hand, mutual funds usually adopt a more conservative approach. They’re restricted from borrowing to invest, which might limit their growth potential but also reduces your risk. Mutual funds diversify their holdings more than investment trusts, spreading out investment across a broader range of assets to mitigate risk.

Market Trading

When comparing investment trusts and mutual funds, it’s essential to grasp how they’re traded on the market, as this influences their liquidity and pricing.

You see, investment trusts are traded like stocks on a stock exchange. This means you can buy or sell shares of an investment trust throughout the trading day at market prices that fluctuate based on supply and demand.

On the other hand, mutual funds operate differently. You buy or sell shares directly from the mutual fund company at the end of the trading day at the NAV, which is determined after the market closes.

This guarantees everyone gets the same price that day, providing a more stable and predictable investment. Still, you cannot make immediate decisions on movements.

Fees and Expenses

With mutual funds, you’ll often encounter management fees and administrative costs that can vary significantly from one fund to another. Additionally, some mutual funds charge load fees, which are basically sales charges applied either when you buy (front-end load) or sell (back-end load) shares.

These fees are meant to compensate brokers or sales agents, but they directly reduce your investment’s value.

In contrast, being traded like stocks, investment trusts typically don’t have the same type of sales charges. However, you’ll still face brokerage fees whenever you buy or sell shares on the stock market.

It’s also worth noting that investment trusts may have management fees, but these are often lower compared to mutual funds due to the closed-end structure. This cost efficiency can be a significant advantage for long-term investors.

Dividend Policy

With investment trusts, you’re looking at a structure that often aims to provide steadier dividends. This is because they can retain up to 15% of their income in any year, providing a buffer that can help smooth out dividend payments over time, even in less profitable years. This feature can make them particularly appealing if you’re seeking consistent income.

On the other hand, mutual funds distribute nearly all their income and capital gains to shareholders each year. The amount you receive can vary significantly yearly, depending on the fund’s performance and income. This means your dividend income from mutual funds might be less predictable than investment trusts, though it’s relatively safe and not some sort of pyramid scheme.

Conclusion

Imagine you’re choosing between two ships for an ocean journey:

An investment trust is like a sturdy galleon, charting a steadier course with a fixed crew size.

On the other hand, a mutual fund is more like a nimble schooner, adjusting its sails and crew as the wind changes.

Both navigate the financial seas, facing storms of market fluctuations and winds of economic change.

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.

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Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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