The Beginner’s Guide to Investment Products (Part 2: Unit Funds and ETFs)

In the first part of our beginner’s guide, we explored the two fundamental investment products everyone should know about: Bonds and Shares. Now that we know the basics, let’s move on to more complex investment products. What qualifies these as more complex?

A lot of things. Like knowing what makes them tick, what returns to expect, and the fact that I’m writing this after 11 pots of coffee at three in the morning. These days, my main problem is having too much blood in my caffeine system. Dodge my degree of stress, and learn the easy way:

 

1. Unit Funds

A unit fund is a collective investment. Investors form a unit fund by pooling their money into a common portfolio. These investors have units in the fund, which are traded on the market like shares.

A financial professional is paid to manage the fund, and is referred to as the fund manager (some funds may have more than one manager). Individual investors don’t decide what goes in and out of the fund’s portfolio; the fund manager alone is responsible. As such, the returns of a unit fund are highly dependent on the competence of the fund manager.

It’s believed that unit funds are safe investments, due to diversification. For example, say a fund consists of stocks in Starhub, SingTel, and M1, among others.

If SingTel loses customers, odds are those customers will go to Starhub or M1. So although the fund’s SingTel stock falls, its Starhub and M1 stocks will compensate.

For the entire fund to fall in value, it would require two or three of those telco stocks to fall at the same time. That’s not impossible, but it is less probable. In addition, it is a bit cheaper to buy units in a fund than to buy all those stocks individually.

 

 

The drawback to a fund is the often hefty price of the fund manager. In addition, the fund has to be advertised, there are switching costs for buying and selling, etc. These all come under the fund’s Total Expense Ratio (TER).

The TER takes away a percentage of the fund’s returns (often around 2%).

Different funds cater to different objectives. Based on the investors’ goals, the fund manager will decide whether to aggressively pursue higher returns, go for long or short term strategies, or tweak the asset allocation.

Common objectives that funds have are:

• Passive Income – The fund pays out regular dividends, and the fund manager is more focused on high dividend yield than the capital appreciation of the fund.

• Retirement – The fund might aim at beating the Consumer Price Index (CPI), thus keeping the investors ahead of inflation. This doesn’t mean the fund manager’s trying for the highest possible returns; the manager might be happy just to stay ahead of inflation.

• Capital Appreciation – The fund is focused on capital appreciation, so that investors will turn a profit when they sell it.

It’s impossible to cover every available type here; the market has more funds than a public toilet has bacteria. Speak to multiple financial advisors, to find funds that might suit you.

 

 

How Much Does Buying a Unit Fund Cost?

The price of the fund is based on its Net Asset Value (NAV), which reflects the market value of the fund’s assets.

Buying a unit fund is a little more complicated than buying shares. The cost can be a single price, or you might have to bid. There is a further subscription charge, which is deducted from the amount invested before units are allocated.

You need to check the prospectus of the fund for further details.

Points to Note About Unit Funds

• Not all unit funds pay dividends. Check in the prospectus before buying.
• The terms “unit trust” and “unit fund” are often used interchangeably. This is not technically correct, as there are unit funds that are not structured like unit trusts.

 

2. Exchange Traded Funds (ETFs)

Before reading this, read about the Unit Funds (point 1).

An Exchange Traded Fund (ETF) is a collective investment, like a unit fund. Investors also buy units in an ETF. But unlike unit funds, an ETF aims to track or replicate a particular index; for example, the Straits Times Index (STI) or the S&P 500.

 

 

The returns of an ETF are meant to match the index that it tracks or replicates. That means the performance of the ETF will match the performance of the market in general, rather than the performance of a few specific companies in the market. Which, I realize, is a paragraph that may as well be in Greek for the layman.

Here’s a highly simplified example:

Let’s say I want to track the STI. I would buy a bunch of shares from many different companies, and create a basket of stocks. This basket would be a microcosm, or miniature, of the STI (not technically correct, but a close enough example).

When the STI as a whole makes money, my miniature version should as well. And vice versa when it goes down.

Now, remember that the STI is composed of many different companies. For it to slide, the majority of those companies would have to make a loss. And as I mentioned in point 1, it’s improbable that so many companies go tumbling downhill at once.

As an added advantage, because ETFs track an index, they are passively managed. There’s no need to pay a fund manager, so you get more of the returns. ETFs also pay good dividends, which appeals to passive investors.

How Much Does Buying an ETF Cost?

The costs of ETFs can be quite variable. However, most ETFs have TERs that are much lower than unit funds (around 0.5%). It is possible to start buying ETFs with fairly low capital (as little as a $1,000, depending on the going rate at the time).

 

And Finally…

In the last part of our article on basic investment products, we’ll cover REITs and also a little on how you can utilize your savings in your CPF account. Stay tuned by following us on Facebook.

 

A MoneySmart Investment Series in collaboration with SGX

This is the third article of a 6-part series, focusing on investment for beginners. For more on starting your investment plans, like SGX on Facebook and subscribe to SGX My Gateway here. In this series, we’ll be introducing you to the most basic elements of the stock market, and how a non-expert can still profit from it. If you are new to this series, do read the first two parts here:

Part 1: Why the Smart Money’s on Investors, not Savers

Part 2: What Kind of Investor Are You?

 

Image Credits:
Tax Credits, Abhisit Vejjajiva, Lars Ploughmann, JMR_Photography,