Let’s talk about investment funds

Henry

Most of the middle class’ savings are locked up in two places: their primary residence, and their pension or retirement fund. It is precisely this state of affairs that makes me so angry when commentators tell everyone to move everything overseas – how exactly should I do this with my house?

But how do those unit trust funds work? And how does it differ from, for example, shareholding, buying property and so on? How safe is my money? And who runs it?

Okay, some of the technicalities here can make a scrum, or even cricket’s more obscure rules, look close.

I’m not going to (and anyway can’t) touch on all facets of these things here.

However, I hope, if you have finished reading this, that you have more of an idea of ​​how these types of funds, which in the vast majority of cases form the backbone of “ordinary” people’s investments, function.

This is just basic information as always.

Sidestep: The GEPF

Just one thing before we get into the meat. The State Service Pension Fund (GEPF), and other similar funds, is its own thing. How they invest and how they pay out is a story for another day.

They are mostly direct investors, in shares for example, but also have other objectives than just yield, which we will not go into in detail today. The GEPF also operates significantly differently when it comes to payouts on retirement.

What is a unit trust?

Unit trusts, or collective investment schemes, basically work like this: a fund, let’s say Balanced Fund A, has a certain mandate. For our example we are going to say inflation plus another 4% growth in say five years.

Me, and you, and your cousin Pieter-Johan, and aunt Baby down the street all invest our money in this fund. They then take all of our money, and the others who invest in it, and in turn invest that money in line with their mandate.

My R100 and your R100 and so on are then pooled together to buy things like shares, and government bonds and so on. For our R100 we might get 10 units in the fund. This is why I believe the English term, unit trustor even the American term, mutual fundis a better description.

Five years from now, hopefully, the underlying value of my units has grown – shares have paid dividends, or been sold at a profit, so on. Then your 10 units are no longer worth R100, but say R125.

Then your investment grows.

Now: different funds have different mandates. Some are extremely conservative and conservative, others only invest in cash and similar instruments – think money market funds. Or maybe long-term capital growth is the goal. The mandate and objective will determine how and where investors’ funds are invested.

Most “ordinary” people, pension funds and so on invest via these types of unit trusts. For example, not all of us have the knowledge or cash to buy and rent property, or to buy government bonds.

If we all pool our money, we can get there.

It would not be incorrect to say that unit trusts are the building blocks of most investments, whether you are going to invest in them directly, or via something like an endowment policy or pension fund.

What are its advantages and disadvantages?

The biggest advantage, in my opinion, is that it allows you to invest in a variety of financial instruments, without needing the funds to buy 100 Naspers shares.

It’s also very liquid. Depending on what type of product it is in, it can take as little as four or five working days to withdraw the funds (obviously this does not apply well to retirement funds). That’s fast enough for an emergency, and long enough to avoid financing your avocados at the supermarket with it.

It also makes it much simpler, because you don’t have to be an expert in the stock or bond market or whatever. You basically delegate it to someone else – like you get a plumber to come clean your clogged drain pipe.

Unit trusts are also, depending on the type of fund and so on, quite cheap, especially if you don’t put them in something like an endowment policy.

It’s still complex though, because there are literally thousands of funds out there, at an awful lot of companies. And that’s just on the spot. The investment fund itself is also only one part of the sum – the product in which it is donated is just as important.

While your risk is mostly lower with these types of funds, it is also the case that your return will not always keep up with direct investments. Think of it this way – if you buy and rent a house, you bear all the risk that it will become a typing factory, but also bring all the income to you.

Unit trust funds are not direct – you are for all practical purposes an indirect or sub-shareholder, which helps protect you from the risks. But it also means that you are not creating all the profit.

How do I choose one? Or more?

How long is a piece of string? What I mean is, there are a lot of gears turning here. How long is your term? Longer terms can afford more risk.

How much can you put away? Is it monthly or one time? Larger amounts often benefit from diversification from more than one fund, where smaller amounts benefit less from such a thing.

How much return do you need over time? What is your own risk appetite? The more return you need (and remember, most investments are not guaranteed), the more risk you need to take. Your own risk appetite refers to how comfortable you are with risk. It’s probably less important than where you want or need to end up. You may be an extremely conservative investor, but if you’re saving for retirement and you start saving in conservative funds at 25, you’re going to cry long, long tears come 65.

Look at companies too. Some of the fund managers have been around for decades, with proven track records. Now, historical performance can’t just be viewed as what will happen in the future, but a fund that has been around for 20 years with an excellent record, and billions under management, is going to look at your money differently than your friend Wolf de Hunter who started with investments yesterday and now manages a fund from his garage.

Find out if the companies are registered with the relevant regulators – at least this provides some protection.

All registered unit trust funds also have disclosure documents that contain information such as what they invest in (at least their top ten largest investments), what their mandate and costs are, what their historical performance is, and so on.

Last word

This is indeed just an overview. We haven’t even touched on costs, taxes, uncorrelated funds, platforms, international fund and so on.

Things are complex, and I strongly suggest you talk to someone who will look at your specific situation holistically and give advice based on that.

This is just knowledge to empower you. Remember, too little knowledge may make you overconfident, because you don’t know what you don’t know.

In any case, it’s always a good idea to keep financial decisions away from emotions, if possible. Because those two are about as good bedfellows as pilchards and condensed milk on toasted rye bread.

  • Leon-Ben is a financial advisor, writer and musician of Wellington.
  • This series of columns follows from the community research of Solidarity Helping Hand. Visit Helping Hand’s website to download the full research reports.
  • Also read “Most SA’ers use a third of salary for debt” on RNews.