Question
Are individual equities (including Investment trusts and Exchange Traded Products ) suitable for ordinary investors in general ? I ask this in relation to the risks and costs involved.Answer
Yes, provided they understand and are comfortable with the nature of the investments and inherent added risk versus a comparable unit trust.
In general terms, the additional risks due to the structure of investment trusts and ETFs are as follows:
Investment trusts
- investment trust shares often trade at a different price to the market value of the underlying investments (called 'net asset value' - the equivalent of unit trust unit price). For example, if an investment trust is trading below its net asset value (most do) it's said to be trading at a discount. If the discount widens then you could lose money even if the underlying investments haven't fallen in value (and, of course, vice-versa).
- investment trusts can borrow money to invest, called 'gearing', the average currently being about 9%. This means if you invest £100 the investment trust might borrow another £9 to give you £109 of market exposure. Good if markets rise, but it'll increase losses if markets fall.
ETFs
- if the ETF is 'synthetic', i.e. rather than buying shares the fund arranges for an investment bank to pay the promised return, then you might lose money if the investment bank(s) concerned doesn't pay up as promised. This is called 'counterparty risk'.
- if the ETF lends stocks to someone else (a common practice for many funds, not just ETFs) and the other party doesn't give them back, you might lose money - another form of counterparty risk.
See my article here for a more in depth explanation of these risks.
Shares are theoretically more risky because your investment depends on the fortunes of just one company, whereas a fund might hold 50 or more companies, helping to spread risk. But investing via shares is also cheap, as you don't need to pay a fund manager. I think this route is fine provided you do some research, appreciate the risks and are confident picking more winners than losers, as in a worst case scenario your investment could be wiped out if the company goes bust.
The other thing to consider is that neither shares, investment trusts nor ETFs are covered by the Financial Services Compensation Scheme (FSCS).
On balance I think both investment trusts and ETFs can both be well worthwhile, depending of course on the exact fund you select. Because neither product pays either sales commissions nor platform fees then charges tend to low, especially so for ETFs which are usually tracker funds (so there's no expensive fund manager to pay). I don't think buying shares directly is for everyone, but it's a route that some investors have used with great success.
Are individual equities (including Investment trusts and Exchange Traded Products ) suitable for ordinary investors in general ? I ask this in relation to the risks and costs involved.Answer
Yes, provided they understand and are comfortable with the nature of the investments and inherent added risk versus a comparable unit trust.
In general terms, the additional risks due to the structure of investment trusts and ETFs are as follows:
Investment trusts
- investment trust shares often trade at a different price to the market value of the underlying investments (called 'net asset value' - the equivalent of unit trust unit price). For example, if an investment trust is trading below its net asset value (most do) it's said to be trading at a discount. If the discount widens then you could lose money even if the underlying investments haven't fallen in value (and, of course, vice-versa).
- investment trusts can borrow money to invest, called 'gearing', the average currently being about 9%. This means if you invest £100 the investment trust might borrow another £9 to give you £109 of market exposure. Good if markets rise, but it'll increase losses if markets fall.
ETFs
- if the ETF is 'synthetic', i.e. rather than buying shares the fund arranges for an investment bank to pay the promised return, then you might lose money if the investment bank(s) concerned doesn't pay up as promised. This is called 'counterparty risk'.
- if the ETF lends stocks to someone else (a common practice for many funds, not just ETFs) and the other party doesn't give them back, you might lose money - another form of counterparty risk.
See my article here for a more in depth explanation of these risks.
Shares are theoretically more risky because your investment depends on the fortunes of just one company, whereas a fund might hold 50 or more companies, helping to spread risk. But investing via shares is also cheap, as you don't need to pay a fund manager. I think this route is fine provided you do some research, appreciate the risks and are confident picking more winners than losers, as in a worst case scenario your investment could be wiped out if the company goes bust.
The other thing to consider is that neither shares, investment trusts nor ETFs are covered by the Financial Services Compensation Scheme (FSCS).
On balance I think both investment trusts and ETFs can both be well worthwhile, depending of course on the exact fund you select. Because neither product pays either sales commissions nor platform fees then charges tend to low, especially so for ETFs which are usually tracker funds (so there's no expensive fund manager to pay). I don't think buying shares directly is for everyone, but it's a route that some investors have used with great success.
Read this Q and A at http://www.candidmoney.com/questions/question518.aspx
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