Unit Trusts compounding return?

stphnstevey

Just wondering if someone knew if you would consider Unit Trust return compounding or not ie like an interest rate?

For example would the return of say 15% on Unit Trust A for Y invested be:

Year 1: Y x 15% = Z
Year 2: Z x 15%

OR

Year 1: Y x 15%
Year 2: Y x 15%

oldfella

unit trusts that have income reinvested mean that in year 2 you have more units to earn income, so yes its effectively a compound return. But note it is not interest, its a dividend which depends on the success of the companies. And not all unit trusts receive an income.

sabretoothtigger

Sometimes they dont increase the units you own, the price just goes up more quickly. In theory theres no income, helps with tax but its still basically a compound return I think

Your 2nd example is where income is paid out or theres nothing to pay like oldfella says

stphnstevey

Thanks - I was trying to make a simple comparison to property or money in the bank. But when I thought about it, it was hard to come up with a formula for the return per year.

I have heard quoted returns on average of 10-15% - but was trying to figure out exactly what this meant.

eg 10K invested just gets say 10% return per year. But after year 1, what happens to the previous years 10% return?

turbobob

Nothing happens to it, it either goes up further or goes down.

So, you invest £10,000 and it goes up exactly 10% a year over the following five years, ignoring charges your investment would be worth £16,105. This never ever happens in real life (unless you invested in something like Madoff's hedge fund. which only ever went up....).

Investments go up and down. So if you invested £10,000 and got the following performance, what would the investment be worth at the end of 5 years and what is the annualised return over the period?

Year 1 -22%
Year 2 +16%
Year 3 +4%
Year 4 +12%
Year 5 -4%

stphnstevey

I realise there are 100s of variables and but you have to simplify things otherwise your formula would be huge and I am only looking at a ball park. I didn't mention, but I have taken charges into account.

If there was no compounding, the £10k invested would grow only by 10% a year or £1k, so after 5yrs total £15k.

So your saying that it would compound then as you said it the five year figure was £16,105?

I understand that dividends can be reinvested and this could cause compunding. But simply if the value of your fund goes up, I don't think that means you have more of that fund, you have the same amount just that the fund price has increased. Therefore there wouldn't be any compounding on the increase in value of the fund?

turbobob

Yes, 10% annualised return on £10,000 over five years would equal £16,105 so that's compound.

With the example of the investment returns in the post above, here is how I've worked it out (I'm not an actuary, just have a working knowledge of Excel )

Initial investment              10000.00
Value at end of year 1 (-22%)   7800.00
Value at end of year 2 (+16%)   9048.00
Value at end of year 3 (+4%)    9409.92
Value at end of year 4 (+12%)   10539.11
Value at end of year 5 (-4%)    10117.54

Total return [B]1.175%[/B]
Annualised compound growth rate over 5 years = [B]0.234%[/B]

I understand that dividends can be reinvested and this could cause compunding. But simply if the value of your fund goes up, I don't think that means you have more of that fund, you have the same amount just that the fund price has increased. Therefore there wouldn't be any compounding on the increase in value of the fund?

Dividends and capital growth contribute to your total return. If you bought units at £1 and they go up by 10% in a year, the unit price would be £1.10, agreed? If the next year the fund goes up by a further 10%, then the unit price would be £1.21. I'm not sure what you mean by "I don't think that means you have more of that fund" - what you have is worth more.

The mechanics differ depending on if you have accumulation or income units. Accumulation units include the dividends in the price. When the fund pays the dividend, the unit prices goes up by an amount to reflect this. Income units distribute (pay out) dividends as cash, which can either be re-invested to buy more units, or paid to you as an income. Many funds offer both income and accumulation units. There should be no difference in returns from one type to the other. Obviously if you need income from the investment you would choose income units.