Investing Unit 8: Unit Investment Trusts

• Introduction
• Unit 1: Basic Building Blocks of Successful Financial Management
• Unit 2: Investing Basics
• Unit 3: Finding Money to Invest
• Unit 4: Ownership Investments
• Unit 5: Fixed-Income Investing
• Unit 6: Mutual Fund Investing
• Unit 7: Tax-Deferred Investments
• Unit 8: Investing Small Dollar Amounts

• Investing Tax-Deferred
• Buying Stocks
• Buying Fixed Income Investments
• Unit Investment Trusts
• Mutual Funds
• Summary
• Action Steps
• About the Author

• Unit 9: Getting Help: Investing Resources
• Unit 10: Selecting Financial Professionals
• Unit 11: Investment Fraud

• Study Guide
• Action Steps
• Monthly Investment Messages
• Glossary

Diversification For $1,000

Unit Investment Trusts (UITs) are a low-cost diversified investment product that can include either fixed-income securities (e.g., municipal bonds, Ginnie Maes) or stock. UITs are sold to investors by brokerage firms in small denominations called units. The cost of a unit is generally $1,000. The securities that comprise a UIT are professionally selected and of a similar type (e.g., investment grade municipal bonds with 30-year maturities). Unlike mutual funds, however, UITs are not professionally managed. Instead, the securities in the portfolio are simply held to maturity to generate interest or dividends, which are periodically distributed proportionately to investors. If a UIT includes bonds that are called (redeemed by the issuer prior to maturity), investors get back part of their principal early. When the last security in a UIT portfolio is redeemed, the trust ceases to exist.

UITs offer diversification at a low cost. For just $1,000, an investor can become part-owner of a portfolio of, perhaps, 30 municipal bonds that would sell individually for $5,000 and would require a total of $150,000 to purchase. UITs can also be used to purchase units of Ginnie Maes, which are portfolios of VA (Veterans Administration) and FHA (Federal Housing Authority) mortgage securities packaged by the Government National Mortgage Association (GNMA).

Ginnie Maes typically sell in minimum denominations of $25,000 so investing in them directly through a UIT makes them affordable for small investors. Investors in Ginnie Maes and Ginnie Mae UITs receive both interest and a return of principal as homeowners repay their mortgages. Distributions are generally paid monthly and the interest portion is taxable.

While originally developed as a vehicle to sell fixed-income securities, UITs have also been used to sell stocks. Common UIT stock investments are trusts that buy equal shares of the 10 highest yielding stocks that make up the widely quoted Dow Jones Industrial Average (DJIA) stock index (a.k.a., “The Dow Ten” or “Dogs of the Dow”). The “Dogs of the Dow” is considered a “value investing” strategy because it invests in out-of-favor stocks that offer better bargains among the 30 large company stocks that comprise the DJIA.

Like bond and Ginnie Mae trusts, “Dow Ten” UITs are packaged and sold through brokerage firms, generally in units of $1,000 each. Instead of having to spend upwards of $50,000 to buy 100 shares of the Dow 10 stocks, ownership can be achieved at a fraction of this cost. Of course, there is “no free lunch,” and UITs of all types (stocks and fixed-income securities) also have their downside. The first drawback is brokerage commissions, which are generally 3% to 5% of the initial purchase. To amortize this expense over time, it generally makes sense to “buy and hold” a UIT until it is dissolved. UITs containing bonds that can be called also are subject to unpredictable distributions and reinvestment risk (the risk of having to reinvest principal at a lower interest rate).