Most people start investing for retirement through a 401(k) or IRA. While these vehicles are a great place to start, you should consider expanding your portfolio, especially as you earn more money. By using different types of investments, you can plan strategically for the future, whether that means protecting against inflation, reducing your tax liability, generating guaranteed income, or achieving some other goal. One saving instrument that you should be familiar with is the unit investment trust (UIT). A UIT is an investment company that has a fixed portfolio offered for investment through redeemable units over a specific period of time.
In many ways, UITs operate like mutual funds, since they are pooled investment vehicles managed by a portfolio manager. However, UITs are meant to provide capital appreciation or dividend income, if not both. UITs invest in an array of stocks and bonds, although other securities may also appear in their portfolios. They typically follow a “buy and hold” approach—the UIT will buy a fixed portfolio of securities and hold them, rather than actively trading them. Investors in a UIT generally know from the outset exactly what they’re investing in for the entire course of their investment. UITs also terminate at predetermined end date.
The primary benefit of a UIT is the ability to invest in a diversified portfolio with a relatively small initial amount of money. UIT trades do not need to take place in a secondary market. Investment advisors can sell UITs, which the owner then redeems to the fund or trust. Investors are considered joint owners of the UIT and have proportional ownership in the company’s underlying securities.
The Difference Between a UIT and a Mutual Fund
Investors redeem UIT units at net asset value, which is the total value of the portfolio (assets minus liabilities) divided by the number of outstanding units. This value is calculated each business day. This distinction makes UITs different from mutual funds, which are sold as shares on secondary markets at the current market price. Investor demand determines the price of a mutual fund while market performance of underlying assets determines the value of a UIT unit. In the United States, about 5,000 UITs exist. Their total market value is nearly $75 billion as of early 2020.
There’s another important distinction between UITs and mutual funds that you should understand before investing in either. A mutual fund is open-ended, which means that the portfolio manager can buy and sell securities to change the portfolio over time. Managers do this to help outperform a specific benchmark. From the investor’s standpoint, an open-ended fund means that the shares can be traded on a secondary market. However, if an investor intends to hold a fixed portfolio and collect interest, then a closed-end fund like a UIT makes more sense.
The Important Points to Consider with a UIT
Of course, not all UITs are the same. If your investment goal is collecting interest over time, consider a UIT that focuses on bonds. A bond UIT will pay the interest income on the bonds held until the specified end date. At that point, the bonds are sold and the principal is returned to the owners. This approach is often simpler than holding several bonds in a personal brokerage account.
UITs that invest in stocks also exist, but they involve greater risk. Stock UITs are notoriously less predictable because they depend on market performance of predetermined stocks, and losses are not uncommon. At the same time, the potential for higher returns attracts some investors to a stock UIT.
While UITs are taxable investment instruments, they can play an important role in an investor’s tax strategy. At the end of the trust’s term, when all investments are sold, stocks that have lost value provide deductible capital losses. This can soften the blow of investment losses and control tax liability. On the other hand, if you decide to cash out rather than wait until the UIT runs its course, you could face quite substantial capital gains taxes. Therefore, it’s important to think ahead about how investments could affect your tax decisions both now and in the future, especially in retirement.
A Real-World Example of a UIT in Action
For many investors, a closed-ended fund can be difficult to understand because they’re less common. That’s why it can be helpful to look at a specific UIT. One of the popular options is the Global 100 Dividend Strategy Portfolio Series 14 with Guggenheim, which was started in March 2018. This UIT is specifically designed to provide investors with dividend income. The UIT invests about 45 percent of its portfolio in large-cap stocks, with 27 percent in mid-caps and 28 percent in small-caps. Half of these securities are American companies and the rest are international, with many sectors represented. Each company in the portfolio represents about 1 percent of the portfolio.
This distribution of stocks will not change over time. Moreover, the UIT will be liquidated at a specific time. The underlying stocks will be sold at market value and the earnings will be distributed proportionately among investors. Investors buy into the UIT with units, which can be redeemed back to the fund at the market value or held until the UIT’s liquidation to receive dividend income in the meantime. When investing in the UIT, investors can see exactly which companies are in the portfolio and make a decision about how many units to buy based on what they think will happen with the stocks.