Investment trusts explained
Investment trusts have been around since the 1800s, with the original investment trust still operating today, and they can still be a good option if you want to diversify your investment portfolio. On this page, you’ll learn everything you need to know about investment trusts, so you have all the information you need to decide if this is the right type of investment for you.
- With investment trusts, you pool your money along with other investors, and a fund manager makes decisions on where to invest to get the best returns
- Investing in investment trusts can come with lower risks than other types of funds because you’re investing across multiple companies
- You may be taxed on the dividends you receive from your shares, and the rate you pay will depend on the income tax band you’re in
Table of Contents
What is an investment trust?
Investment trusts are listed companies that trade on the London Stock Exchange using funds from collective investment, meaning the funds from shareholders and investors are pooled, and the money is invested in a diversified portfolio. When you invest in an investment trust, you’re buying their shares, the value of which can fluctuate depending on the stock market.
How do investment trusts work?
When you purchase shares in the investment trust, your money is pooled with money from other investors. This pot of money is used to purchase a wide range of assets and shares, which will usually be decided by the trust’s fund manager. The value of the shares purchased can fluctuate over time and will be bought and sold to make profits.
Investment trusts tend to be more stable than purchasing shares from a single company because your money is invested diversely, which means it will be invested across a variety of companies. Although this will not eliminate the risk of loss, it can lessen the impact of having a poor performing share, thanks to other shares that can potentially counteract that loss.
How much does an investment trust cost?
The cost of investing in an investment trust will vary, but they usually have the following fees in common:
- Management fee: the fee imposed by the fund manager for managing the investment trust.
- Performance fee: some investment funds charge performance fees, which are payable when the trust outperforms certain benchmarks. For example, if your trust doubles in value, you may have to pay an extra fee. However, if the trust isn’t able to reach the level set for performance fees, then no fee will be applied.
- Annual charge: the annual charge covers the cost of investing in the trust itself, and typically ranges from 0.5% to 1%.
- Flat rate: some investment funds use flat rates rather than a percentage, which can be more cost-effective, especially if you wish to invest a large amount of money.
What are the tax implications on investment trusts?
Tax implications on investment trusts are the same as they are on any other investment fund. That means you may pay tax on dividends* and profits you earn. Every UK citizen has an annual £2,000 dividend allowance, which is the amount you can earn through dividends without having to pay tax. You’ll need to pay tax for earnings over your dividend allowance, with the amount you’ll need to pay depending on your income tax band.
|Tax band||Tax rate on dividends|
You may also pay capital gains tax when you sell your shares for a profit. In each tax year, you can earn up to £12,000 in profit before having to pay capital gains tax.
Benefits and risks of investment trusts
|Shares are purchased diversely, which means you’ll own various shares in different companies. If the price of shares in one company falls, other shares may be able to make up for that loss.||The price of shares increases and decreases, meaning there’s a chance you’ll lose the money you’ve invested.|
|You’ll know where your fund manager will invest your money. If you find that the manager is taking risks that you’re not comfortable with, you can choose to invest elsewhere.||The level of risk you’ll encounter can depend on the investment trust you choose. Fund managers are responsible for where the money you invest will go, which means you won’t be in control once you invest.|
|Investment trusts provide information on their performance, which you can use to make decisions on whether or not you should continue to invest.||If the investment trust borrows money to purchase shares, returns may be better, but equally, a loss can have a greater effect.|
Are investment trusts safe?
All types of investments come with a certain level of risk, and investment trusts are no exception.
The success of an investment trust is generally tied to the fund manager, who decides where to invest your money. It’s also important to check whether the Financial Services Compensation Scheme (FSCS)** covers your fund. This scheme is designed to compensate investors in the event the company they’ve invested in has failed, providing up to £50,000 per person, per firm. Note that poor investment performances don’t mean you’re entitled to compensation, or to put it another way, you won’t receive compensation if your fund manager invests in shares that fail.
Is an investment trust right for me?
Before investing in an investment trust, you must first consider how much risk you’re willing to take. Should your investment lose value, will you be able to handle this loss?
You’ll also need to consider how long you plan to invest for. In most cases, the longer you’re willing to invest your money for, the better returns you’ll see. If you’re looking for quick returns, an investment trust might not be a suitable choice for you.
What are the alternatives to investment trusts?
If you don’t want to take the risk of investing, you may want to consider opening a savings account instead. Fixed rate bonds, for example, allow you to lock your money away for a set amount of time, and the competitive interest rate is fixed, so you’ll know exactly what your return will be.
If you want to quickly and easily open a fixed rate bond, register for a Raisin UK Account and apply today.
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