Why the FTSE 100 could be a better buy than any investment trust

Investment trusts are a great asset to use to invest for the future. These instruments, which are structured as companies, have been around in one form or another for hundreds of years, allowing generations to build wealth and invest with ease.

One of the key benefits of investment trusts is that they can invest in instruments that are not available to most investors. Some own airplanes they lease to airlines, while others invest in secured and unsecured loans to generate an above average income for shareholders.

Some also offer UK investors exposure to overseas investments, which they may not be able to get access to themselves. The Scottish Mortage Investment Trust, for example, owns shares in retail giant Amazon.

However, while some investment trusts are attractive due to their exotic exposures, others do not have similar qualities.

Unfortunately, a number of investment trusts, particularly income trusts, own a portfolio that's broadly similar to the FTSE 100. And while these trusts may offer higher dividend yields, thanks to overweight allocations to the market's highest-yielding stocks, their fees eat up all of the additional income.

A better buy

The FTSE 100 is the UK's leading stock index, and it's also a great income investment. At the time of writing, the index supports a dividend yield of 3.9%, many times the average interest rate offered on most high street banks' savings accounts today. With this ready-made portfolio of 100 of the biggest companies in the world, it's difficult to see why investors would look anywhere else for income.

Granted, there are funds out there that offer higher dividend yields. For example, the Shires Income plc and Murray Income trusts yield 4.7% and 4.2% respectively, but after you deduct fees, the returns on offer look less appealing.

Counting costs

The iShares 100 UK Equity Index Fund, which tracks the FTSE 100, charges only 0.07% per year, with no initial fees for investors. This means that after deducting fees, investors can look forward to an annual return equivalent to 3.8% from the FTSE 100 excluding capital gains. For the sake of simplicity, I'm going to assume that the returns from this index tracker and trusts are limited to just income to make the impact of fees more apparent.

On the other hand, while Murray and Shires might look more attractive on a yield basis initially, I believe that the fees charged level the playing field. Shires charges a little over 1% per annum in fees, bringing the annual return down to 3.7%. Meanwhile, Murray charges a total of 0.8% bringing the total return down to 3.4%.

I believe that these figures clearly show that as an income play, the FTSE 100 is a much better buy than investment trusts. Trusts might look as if they offer better income potential at first glance, but after deducting fees, investors might be better off.

These numbers exclude capital gains, which could turn the tables back in the trusts' favour. However, with investment trusts you're relying on the skill of the manager to keep outperforming. With the FTSE 100, there's no such risk so you won't end up overpaying for lacklustre returns.

Buy and forget

A FTSE 100 tracker is a great tool to help you produce the best returns on your money with maximum diversification and minimum effort.

Using this approach will help your money grow steadily without the risk of making bad stock-picking decisions.

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Rupert Hargreaves does not own any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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