What is an OEIC?
An OEIC is a type of fund that pools investors’ money and uses it to invest in companies, assets and/or commodities it believes will generate returns.
As the investment vehicle is a company, you’ll buy shares in the OEIC.
It’s not the same as buying shares in an individual company, as the OEIC’s sole purpose is to invest in a diverse portfolio, potentially spanning everything from FTSE100 companies to properties to oil, to generate returns.
OEICs operate in a similar way to unit trusts, with the only difference being that OEICs issue shares rather than units.
Both are different to investment trusts which have a set number of shares they can issue.
OEICs can issue new shares and cancel them to accommodate an unlimited number of investors without diluting the value of your investment — hence the name ‘open ended’.
How do OEICs work?
OEICs work by putting all investors’ money into a collective pot, which gives the fund power to invest across a wide range of valuable assets.
While the actual investments will depend on your chosen OEIC’s risk level, this investment vehicle generally spreads your money across a diverse range of companies and assets.
If one business performs poorly, you’ll have lots of other investments to buoy the fund’s overall performance.
You can either use a DIY platform to invest in an OEIC that aligns with your financial goals, or let your financial adviser choose the right option.
You can also opt for a passive or actively managed OEIC.
Here are the key differences between the two:
Passive funds
- Lower annual fees
- Invest using software across a broad, balanced portfolio set to a chosen risk level
- Runs with minimal human intervention, making you more open to losses or overinvesting over time
Active funds
- Higher annual fees
- A dedicated fund manager decides where to invest the pool of money, aiming to pick stocks, assets and commodities that will perform strongly
- Fund manager can intervene and sell off loss-making stocks or assets
- Even with the most experienced fund manager at the helm, there’s no guarantee you’ll be protected against losses or achieve your desired returns
As with any investment, there are downsides to OEICs.
As with any fund that spreads your investments across companies and asset classes, past performance never guarantees your future returns.
The companies your OEIC has invested in could go bust or the assets could depreciate — even though the fund manager or company will have selected options that are likely to deliver as positive an outcome as possible.
How do I earn money from an OEIC?
If the investments within your chosen OEIC do well, you can generate income in one of two ways:
- Selling shares or units: You can sell your units or shares to other investors. While it’s never guaranteed that you’ll make money, you could if your OEIC has performed well and has risen in value since you invested. For example, if you bought 100 units at £5 per unit and the price has risen to £30 when you sell, you could make a net profit of £2,500 (subject to tax)
- Dividends: if you’re looking to hold your investment for a while, and the fund is performing well, you’ll receive dividends quarterly or biannually. Dividends are a portion of companies’ profits, which are shared with investors as a thanks for their support. The rewards will be smaller than if you sold your units, but they’re more consistent and simpler for passive investors
If you’re investing for the long term, you can either take dividends as income units or shares (and enjoy the money) or opt for accumulation.
This route automatically reinvests dividends into your chosen OEIC to boost your investment’s value.
What’s the difference between unit trusts and OEICs?
In terms of performance, unit trusts and OEICs have a similar purpose.
They both spread your money across a range of assets to deliver balanced returns.
Here are the main differences:
- Unit trusts issue units while OEICs issue shares
- Unit trusts quote two prices for buying and selling (with the latter typically lower) while OEICs generally have a set price per share
- Both are generally priced once a day based on their net asset value (NAV)
- Unit trusts are regulated by trust law, while OEICs come under company law. It’s essentially a technicality, but it means OEIC investors own part of the fund’s assets.
What are the rules around tax and OEICs?
Like all investments, you’ll need to pay tax on any returns you get from your chosen OEIC.
The main taxes UK taxpayers need to consider are:
- Dividend tax – 7.5 per cent (basic), 32.5 per cent (higher) and 38.1 per cent (additional) of anything over the £2,000 annual allowance (which will decrease to £1,000 from the 2023/24 tax year)
- Capital gains tax – either 10 per cent or 20 per cent of all gains over £12,300 (the 2022/23 allowance, which will fall to £6,000 from 2023/24)
If your investments are humble and generate income below the thresholds, you won’t have to pay tax.
But there is another, entirely legal, way to avoid getting taxed on your OEIC income, even if it’s above the tax thresholds…
Using an ISA to invest in OEICs
A stocks and shares ISA is a tax-efficient way to invest in OEICs and other types of funds.
Each provider will offer different products, but you’ll have to stick to the £20,000 annual ISA limit per tax year.
While an ISA can limit the amount you invest, there’s one huge benefit: any gains and income you receive within the ISA ‘wrapper’ are tax free, meaning you can save on dividend and capital gains tax.
If you don’t feel confident investing alone, an independent financial adviser can help you make the right decisions.
They’ll evaluate your appetite for risk and desired returns and help steer you towards investment options that make sense for your circumstances.
