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Unit Investment Trusts: Examining the Potential of Defined Portfolios

An alternative to the common fund. People invest in mutual funds and exchange-traded funds all the time, but unit investment trusts (UITs) remain comparatively underappreciated and unrecognized. They really aren’t that mysterious, and their popularity is growing – in fact, total net assets invested in unit trusts increased 151% during 2009-12.

The word “trust” may make you think of estate planning, but a UIT is not an estate planning tool. A UIT is a Registered Investment Company (RIC), or grantor trust, that typically offers investors a defined, passively managed portfolio assembled to pursue a specific objective. Some UITs have equity portfolios, while others have taxable or tax-free fixed income portfolios.

Low minimums, liquidity & the pursuit of dividends. Conservative and opportunistic investors alike will appreciate the key features of a UIT.

First of all, you always know what you own when you invest in a UIT as its portfolio is defined and fixed. For that matter, so is the life of the unit trust itself. A UIT is liquidated at a predetermined date (which may be anywhere from 13 months to 30 years after its inception). As a unit holder, you will typically have three choices at the date of maturity: you can get a cash distribution from the UIT, you can get an in-kind distribution of the underlying securities (if you own sufficient units), or you can roll over your proceeds to a new UIT (a taxable event).

Second, it doesn’t take much to get into a UIT. Units can be purchased for as little as $1,000 – a small price to enter into an adeptly constructed portfolio built on the vision of investment professionals.

Third, UITs offer liquidity. You can sell or buy units on any trading day, and as with mutual fund shares, units are priced at the end of each trading day.

Fourth, unit trusts aren’t plagued by style drift like some mutual funds are. Whether they are created to beat a benchmark, exploit a hot sector of the market, generate dividend income or provide attractive diversification, UITs stick with their original investments.

Fifth, some UITs have portfolios with income-producing securities that tend to offer potentially larger dividends than bonds – preferred and/or dividend-paying stocks, real estate investment trusts (REITs and master limited partnerships (MLPs) are but a few examples.

Sixth, you won’t have to contend with embedded capital gains if you buy into an equity unit trust at its IPO. Why? Your cost basis reflects the net asset value (NAV) of the units on the date of purchase – so in terms of tax implications, each investor entering the trust gets a “new” investment. Compare that tax treatment with an open-ended mutual fund, in which dividend and capital gains payouts (and resulting tax liabilities) are figured per calendar year – whether you buy shares of a fund in Q1 or Q4, the tax liability for a given year is the same. If you profit as you redeem your units, you will pay capital gains taxes – but before then, you won’t.

UITs come with risks, of course. The good news is that the risks are fairly obvious. At termination or liquidation, your investment could be worth much less than it was at the trust IPO or whenever you purchased the units. The portfolios constructed by unit trusts are passively managed, and you can certainly hold too long when it comes to buy-and-hold investing. Investments in fixed-income UITs are subject to the usual risks associated with owning individual bonds. Additionally, UITs come with fees: the typical unit trust investor gets dinged with annual expenses, front-end and deferred sales charges and a creation and development fee.

Investors hungry for yield are looking into the potential of less-publicized investments. If you are among them, you might want to look at unit investment trusts.

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About the Independent Financial Advisor

Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.

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