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Where to start in the stock market as a new investor? There are many options; in fact, thousands and thousands. That can be confusing. One approach I think new and old investors should consider is buying shares in an investment trust.
What exactly is an investment trust?
It is basically a pooled fund. Then the company has money that it uses to buy shares of other companies. He then sells shares of his own company, which investors can buy. Its own price can rise and fall regardless of the valuation of your portfolio. Because of this, these trusts are sometimes sold at a discount (or premium) to a sum-of-the-parts valuation of their portfolio.
I think there may be some good reasons to buy mutual funds, but also some cautions. Of course, like any investment, some trusts do much better (or worse) than others.
My points below relate to investment trusts in general, not one specific one (although I use one to illustrate some points).
Easy diversification
A key principle of risk management is to avoid concentrating too much risk in one place. It sounds simple… and it is. But diversification is no less powerful or important for that.
Because investment trusts typically buy dozens or even hundreds of companies, they offer an easy form of diversification.
Expert managers – sometimes
Some trusts track an index or use some other automated trading strategy. Others use managers – often at great expense – to choose which stocks to buy (this is the difference between what are known as passive and active approaches).
Consider Scottish Mortgage Investment Trust (LSE: SMT) as an example.
Its share price is down 38% in the last three years or so. However, in five years it has increased by 60%. This is more than 10 times the average share price growth seen in FTSE 100 companies in that period.
The explanation for both the three-year decline and the five-year gain is the same: Scottish Mortgage's fund managers have focused primarily on growth stocks, including NVIDIA and tesla.
So the trust's fortunes have to some extent mirrored those of leading growth stocks, due to the investment decisions its trustees have made. Managers can help an investment trust perform much better than the broader market, or much worse.
Access to unlisted companies
Another interesting thing about Scottish Mortgage is its dividend history. The last time it cut its dividend was after the Wall Street crash, almost a century ago!
But as with any stock, past performance is not necessarily a guide to what may happen in the future.
Anyway, if I wanted to buy a stock with a long history of dividends, I have several stocks I could choose from.
However, if as a small private investor I wanted to buy a share of a growing, unlisted company like SpaceX, I couldn't. Guess what? SpaceX is Scottish Mortgage's third largest holding, accounting for more than 5% of its value.
An option to consider
Investment trusts can have other disadvantages besides those I mentioned above, including fees and costs.
Still, in principle I see a lot of things I like about them. So when I'm looking for stocks to buy, I keep them on my radar, although I decide on a case-by-case basis whether a particular mutual fund is right for me.
