For beginners, the idea of investing in unit trusts is appealing as we can leave the stock and bond picking to the professionals. Since many of us do not have the time and expertise to study the performance of individual stocks to identify the “winners”, we may feel it is better to let a professional fund manager do the job for us.
While this may seem like an easy way out, there are six important questions you should ask your unit trust agent before deciding on where to park your money.
1) What will my returns look like?
One way to gauge a fund’s potential is by looking at its risk level. In general, the higher the risk, the higher the returns are likely to be. However, it is important to note that the key word here is “likely” as there is no guarantee. High-risk investment vehicles can still sometimes crash and lead to financial losses.
How much risk you should take will depend on your investment timeframe, risk appetite and lifestyle needs. You have to be very mindful when weighing these aspects so you will be able to handle any potential financial downturns.
2) Could I end up making a loss?
Unit trust investments take the middle ground between high-risk and high-return investment vehicles like stocks, and low-risk low-return vehicles like fixed deposits.
However, like any other type of investment, there is an element of risk involved with unit trusts.
As unit trust funds are investments spread out over several types of investment categories, including stocks, bonds and commodities, there is a reduction in risk as it is unlikely that every single company that the fund invests in would fail.
However, if a unit trust has funds invested entirely in one country/region, should that area face a sudden economic downturn or crisis, your funds could quickly lose their value regardless of the asset or industry spread.
It is important to ask your unit trust agent to explain the worst case scenario before you dip your toes into the investment.
3) What are the upfront and hidden costs?
It is important to be aware of upfront and hidden charges, including yearly management fees as they will erode your profits. Knowing just how much you are paying will enable you to make a meaningful comparison among the cost structure of different funds.
Since these charges are paid up front, it will take some time before you break even, much less make a profit.
4) How do I select the funds that are most suitable for me?
To choose the right funds, you need to be clear about your financial objectives and financial goals. For example are you aiming to generate income or preserve your capital?
Then, think about your investment timeframe and risk tolerance. Are you saving for the short-term to cover a property down payment, or are you saving for a long-term goal such as your newborn’s eventual tertiary education?
In general, younger investors can afford to optfor higher-risk funds, as they have a longer time horizon and more years of earning potential ahead. This will allow them to ride out the market’s highs and lows while benefiting from compound interest.
Other important factors to consider are your financial holding power and how much you can afford to lose as an investor.
Your unit trust agent should then be able to match the right funds to your risk profile and investment goals.
5) How much should I invest?
Again, this would depend on your financial objectives. For those who are saving for retirement, investing in unit trusts can be a useful method for combating the ravages of inflation while preserving the value of their earnings.
According to the Organisation for Economic Co-operation and Development (OECD), in order to maintain the same standard of living post-employment, one should start saving at least 33% of his/her monthly income as early as age 25, to have at least 2/3 of his/her monthly income in retirement.
Your Employees Provident Fund (EPF) contribution provides only 23% to your savings every month (11% from you, and 12% from your employer) – still 10% short of what OECD recommends. Worse, with a projected inflation rate of 3% to 4% per annum, the value of your savings could be significantly reduced over the next decade.
6) What are some of the risks?
Unit trust investments are subject to social, economic and political conditions. Some of the risk factors that unit trust investors face include market risk, default risk and inflation risk.
Market risk occurs when you lose money due to fluctuations in market prices. Default risk happens when the issuer of a bond (companies or individuals) is unable to make timely principal and interest payments.
Inflation risk is the possibility that the value of assets or income from an investment shrinks due to changes in purchasing power attributed to inflation. Any changes in foreign currency exchange rates will also affect the returns of the respective funds.
By asking your unit trust agent the right questions, you will have a better chance of being able to make an educated and informed investment decision — resulting in (hopefully) the “correct” answer of potentially higher returns.