37 Understanding Mutual Funds


Understanding Mutual Funds
One day, Bron and his friend Kobe went out for a coffee..

Bron: “How's your knee doing?”

Kobe: It's still a bit swollen. Doc' says it'll take a couple more weeks.

Bron: I thought it would be just days and you'd be fine?


Kobe: Yeah..If I was 5 years younger.

Bron: So did father time finally caught up with you?

Kobe: Yeah, I guess so.

Bron: And have you thought of retirement yet?

Kobe: I do. But I think I still need to allocate some of my money to an investment that can somehow help me fund my retirement.

Bron: How 'bout investing in the stock market?

Kobe: I wanted to, but I'm pretty busy to check the market and study it.

Bron: How 'bout Mutual Funds? It's a pretty good option in your case.


Kobe: Mutual Funds?

Bron: It's like investing in the stock market. But unlike in the stock market where you directly invest and do it yourself, there are professional fund managers that will do the work for busy people like you.

Kobe: How does that work?

What's a Mutual Fund?
Bron: A Mutual Fund is basically an investment company that pools together money from different investors and invests them in the stock market, government securities and other investment options available to the public. These funds are being managed by professional fund managers, people whose job is to study the market and all kinds of investment instruments.

Kobe: I don't get it, will you elaborate?

Bron: Let's say you wanted to own shares of SM, Ayala, PLDT and Meralco. These are all huge companies. But for you to be able to buy shares from them directly via the stock market, you'll need a big chunk of money. This is where a Mutual Fund company comes in the picture. Let's say Jordan, Wade, Pau and Dirk has all interest in owning some of the companies I've mentioned.

Kobe: Don't include Dirk. I don't even know the guy!

Bron: Fine! Let's say Jordan, Wade, Pau and Kevin has all interest in owning some of the companies I've mentioned. A Mutual Fund company will gather funds from them and buy shares of each of these big companies. That is the main advantage and main purpose of a Mutual Fund, to allow small investors to buy shares from different big companies by means of pooling their money. Another advantage is that since Mutual Funds are managed by professional fund managers, you won't have to worry much because they will do diversification, analysis and investing for you!

Here, take a look at this:

Understanding Mutual Funds


Kobe: I can see my son can draw better than you.

Bron: Give me a break, man! It's just an illustration!

Kobe: Ha-ha! Does this mean I will own shares from all the companies in the stock market?

Bron: No, not necessarily. Fund managers will decide on which companies listed on the stock market to buy. That would be their job.

Kobe: And how do I know if I'm earning or losing money?

NAVPS  
Bron: Through NAVPS or Net Asset Value Per Share. It's the computed price per share of mutual funds.

Kobe: Uhm?

Bron: Mathematically speaking, it's the total Net Asset Value of the company divided by the number of outstanding shares.

Kobe: OK, speak English!

Bron: Ha-ha! Let's say the company bought stocks of different companies. Of course we know that in the stock market, the prices go up and down. Now at the end of each day, these fund managers will compute how much the earnings or losses from the investments on these stocks were. From there, they will compute the value of NAVPS for the next day. However, the computation for NAVPS will vary from one company to another.

Kobe: But why?

Bron: First, because each company has their own fund managers and each fund manager will not invest on the same stocks, right? Second, not all the funds will be invested in the stock market. Meaning, the money will be allocated to different investments in order to diversify. As you can see from my illustration, some of the money may be invested in government bonds or special deposit accounts from banks. Third and last, it depends on the fund allocation you will choose when you open an account with the company.

Kobe: I thought they'd decide on that?

Bron: Yes, but as a shareholder, you will be given an option to choose which type of fund you would want to have.

Kobe: And what are those?

Types of Mutual Funds 
Bron: There are 4 common types of funds: Money Market Funds, Bond Funds, Balanced Funds and Equity Funds.

Money Market Funds invest mainly in short-term investments. And by short-term, I mean months to less than a year only. This is probably a safe place to put your money, instead of placing it as a regular savings on a bank, where money loses its value. Although you may not get great returns, at least you have been saved from fear of losing your capital. Obviously, the objective of investing in this type of fund is to seek capital preservation.

Bond Funds invest primarily in government securities or corporations. The investment objective of this type of fund is to seek stable income and capital preservation at the same time. These is achieved by investing in various fixed-income instruments such as Treasury Notes and Bonds issued by our government or governments of other countries and in corporate bonds which are issued by both local and international companies.

Balanced Funds invest both in stock market and debt instruments.  To provide a balanced mixture of safety, income and capital appreciation is the investment objective of this type.  In simple terms, these are invested in a combination of Bond Funds and Equity Funds

Equity Funds invest mostly in the stock market. Therefore, the investment objective of an Equity Fund is to have a long-term capital growth. Depending on the investment strategy of the fund managers, the fund may be invested in blue-chip stocks, growth stocks and even speculative stocks.

Kobe: Does that mean that they also buy shares from penny stocks or those companies that some investors find unstable?

Bron: Yes. But since they are committed to managing the funds, rest assured that these fund managers will study the performance of these stocks first before investing the funds on them.

Kobe: I can see that the Equity Funds has the highest risk, but has the highest potential of returns because most of the funds will be allocated to the stock market. Bonds, on the other hand, pose the lowest risk although it has the lowest returns.

Bron: That's right. And Balanced Funds is somewhere in the middle of Equity Funds and Bond Funds. But again, the allocation will be different from each company. For example, a Mutual Fund company can put 90% of their Equity Funds to the stock market, 70% when Balanced Funds, and only 10% when Bond Funds.

Fund Allocation 
Kobe: And what happens to the remaining percentages that were not allocated to buy stocks?

Bron: Good question. The remaining funds will then be allocated to other investment options such as government bonds and SDAs or Special Deposit Accounts, as you have seen on my illustration. Here, take a look again:

Understanding Mutual Funds


Risk Appetite
Kobe: OK, I get it. But how do i know which type of fund is best for me?

Bron: It will depend on your favorite color.

Kobe: Huh??

Bron: Ha-ha! I'm just kidding. Normally, they will give you an investor assessment questionnaire that you will need to answer. Your answers on this questionnaire will determine your risk appetite.

Kobe: And what exactly is a risk appetite?

Bron: It's how you handle loss, or should I say how you manage or fear certain risks. Remember that any form of investment comes with a risk, and that includes Mutual Funds. So if you're the type of person that might get sick when seeing the value of your money lose or depreciate, then you probably have a low appetite for risk. But if you're the person who understands how long term works and you still have time on your side, then you may have a high appetite for risk. Just maybe.

Kobe: Can I invest in more than one type of Mutual Fund?

Bron: Yes.

Earning through Mutual Funds 
Kobe: So how do I earn from Mutual Funds?

Bron: If the NAVPS of the mutual funds you are invested in increases or appreciate in value, then you can sell for a profit. But unlike in the stock market where selling means you need to find or wait for a match, in Mutual Funds you simply withdraw your funds from the company and that's it.

Kobe: So how do I know if I earned or not?

Bron: Let's say you've invested 5,000 Pesos on January 2013.  To determine the number of shares you were able to buy from P5,000,  simply divide P5,000 with the NAVPS for that date. That's P5,000 Pesos divided by 3.7811 (NAVPS) = 1,3222 shares.

Date Bought: January 10, 2013
Amount: P5,000
NAVS: 3.7811
No. of Shares: 1,322
Profit/Loss: -109

Now to determine your gains or losses, you just need this simple formula:

(No. of Shares x Current NAVPS) - Value

Let's assume that the NAVPS today is 3.7000:

By substituting the values to the formula, we will get:

(1322 x 3.7000) - 5000

Thus,

4891.4 - 5000 = -108.6 or -109 (rounded off)
 

So if you decide to redeem your funds today, you will realize a loss. That's why Mutual Funds are really best held long-term, especially for Balanced Funds and Equity Funds.
 
Now, what if the NAVPS for today is 3.9580:

That would be:


(1322 x 3.9580) - 5000

Hence:

5232.476 - 5000 = 232.476 or 232 (rounded off)


This time, your money earned 232 Pesos. Isn't that cool?

Now, let's look at the bigger picture, if you will continuously add money to your fund (subsequent payment) every month:

Understanding Mutual Funds

As you will notice, the value of the NAVPS on each payment date is different because the market also changes. The current NAVPS used for this example is 4.000. The initial investment was 5,000 Pesos and the monthly subsequent payments made were 2,000 Pesos until December. The total gain of this fund is now worth more than 2,000 Pesos in just a year! That's about 8% annual return!

Yet if you realize, the figure used here were small. Of course you can put more money than my example. That's why the bigger your investment, the bigger the returns would be.


Liquidity
Kobe: But can I redeem my shares or withdraw my money anytime?
 
Bron: Yes. Mutual Funds is one of the investment options that offers high liquidity or the ability of an investor to pull out his investments anytime.

Kobe: All for free?

Charges and Fees 
Bron: No! The Mutual Fund Company is a company that hires and pays people to manage the funds for investors like you. Therefore you need to pay some fees or charges, similar to banks.

Kobe: How much? Is it as expensive as paying for a stock broker?

Bron: No, and that's the great thing about Mutual Fund companies. The fees or charges are not that expensive and sometimes, depending on the company, you will be given an option when to pay that fee: Front-end or Back-end.

Kobe: What's the difference between the two?

Bron: Front-end means you'll pay upon opening an account. Back-end means you'll pay when you redeem your money. Again, the payment terms and fees will be different from one company to another.

Subsequent Payments
Kobe: How often can I add funds to my initial or existing investment?

Bron: As often as you can. It's also like banking where you can deposit your money anytime you wanted. But of course, we're talking 'bout regular working days and hours here.

Kobe: How about the minimum subsequent payments required?

Bron: That will depend on the company. Some may require a minimum of 1,000 Pesos, others 500 or 2,000. The same holds true for the initial investment. Some may ask for 10,000 Pesos while others may be as low as 2,000 Pesos.

Kobe: Who is the best performing Mutual Funds company in the Philippines today?

Performance History 
Bron: I think there's no objective way to rank them. Because again, some funds are invested in the stock market where obviously, the results are always unpredictable. So what they do is to rank these companies based on past performances. But remember that just like in stock market...

Kobe: Past performance is not an indication of future results?

Bron: Exactly.

Kobe: So can I tell these fund managers where to invest my money then?

Bron: No. Invest directly in the stock market if you wish to do that. What's the sense of having a fund manager if you'd be the one telling them where to invest?

Kobe: OK, I think I'll go for it. What companies are offering mutual funds?

Mutual Funds vs. UITF
Bron: Good question again. But before you head out to any of these companies, let me tell you something about UITF or Unit Investment Trust Funds.

Kobe: What is it this time?

Bron: It's just important for you to learn the similarities and the differences between Mutual Funds and UITF early so you'll be relieved of confusion later.

Both Mutual Funds and UITF are pooled funds and basically applies the same concept we discussed earlier. Now here are the differences:

(1) A Mutual Fund is being regulated by the Securities and Exchange Commission or SEC while UITF is being regulated by Bangko Sentral ng Pilipinas or BSP. 

(2) Mutual Funds is mostly offered by financial institutions such as Sun Life. UITF, on the other hand, are offered by banks such as BPI, BDO, Metrobank and Land Bank.

(3) You buy a share in a mutual fund while you buy a unit in a UITF. 

(4) To know the performance of your investment, you have NAVPS or Net Asset Value Per Share for Mutual Funds and NAVPU or Net Asset Value Per Unit for UITF.

Kobe: So which is better?

Bron: That's like asking who's better between me and Jordan, man.

Kobe: What the??

Bron: Ha-ha! I mean the answer would be based on each investor. Just let me tell you more to help you decide. Mutual Funds will usually cost you to pay higher charges, but funds are well managed. UITF are cheaper in terms of charges but funds are less regulated and have less transparency on their investments. One notable advantage of UITF though is that you can easily manage, fund and review your investments since you can link it with your existing bank account.

Banks vs. Financial Institutions
For services and consultations, I think the people from financial institutions can be of more help to you than those from the banks. It's discouraging to find that some bank people don't even know what a UITF is or that the bank where they work is offering it!

Kobe: Financial institutions sound a little better than banks. OK, thanks man. That was pretty informative. I think I know where to put some of my money now.

Bron: So, when will you finally call it a career?

Kobe: I think after I got that one last ring...

Bron: You wish man, you wish...

- o0o -

Do you want to invest in Mutual Funds but don't know where or how to start? I'll be glad to help you! Just send me your questions or concerns via email or you can contact me here

PisoandBeyond Did you learn something from Bron and Kobe? Receive cool updates like this when you subscribe to PisoandBeyond!

37 comments :

  1. Nice! At least nakarelate po ako..Sana ganun din ang iba pa nating mga kababayan..

    Mang Pedro of OFWs Community

    ReplyDelete
  2. Sobrang ganda ng paliwanag,,prng FullMoon lng hahhhaa, Salamat po ng Marami

    ReplyDelete
    Replies
    1. Salamat din po sa pagbabasa ^_^

      Delete
    2. AnonymousMay 17, 2014

      Sir Jeff sa palagy nyu po saan mgnda mg invest ng MF? alam nyu po ba ang IMG??? nagaalok po sila ng MF eh,,ngbblak aq mg open ng account,,ok lng kya? or sa Sunlife n na mentioned nyo na example ng financial institution n nagaalok ng MF? God Bless po Sir Jeff and Thanks po

      Delete
    3. Hi there, sorry for the (very) late response (Anonymous comments usually gets unnoticed, *sigh*).

      Regarding IMG, yes I think they're a good company. It already has established relationships among other financial institutions such as Philam Life (one of their mentors in IMG includes Philam Life's President/CEO, Mr. Rex Mendoza). I think they actually conduct free seminars/orientation which can be the best time for you to ask all your questions. OK din naman po 'yung Sun Life in terms of managing funds as they already built a solid reputation worldwide. To get you an overview, here's a cheat list on the top performing Mutual Funds as of May 2014 ->> http://mutualfundphilippines.com/2014/06/fund-performance/top-mutual-funds-philippines-may-31-2014

      But again, past performance is NOT a guarantee of future results.

      Thank you so much for reading! God Bless too!

      Delete
  3. Very informative and easy to understand

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  4. i would choose Mutual funds rather than Uitf then.....

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  5. AnonymousMay 13, 2014

    More Power! Thanks guys!

    ReplyDelete
  6. AnonymousJune 13, 2014

    which is better: sunlife or philam life??

    ReplyDelete
  7. this is again a very informative article...sir Jeff,again you came just right in time..my husband and i were thinking of investing in a mutual fund ..last december we took the advice of one of the leading banks in our country....but sad to say they discouraged us in investing at UITF..masyado daw risky at tama ka po hindi nila alam kung ano yung product na ini ooffer nila...dito lng naman po yun sa Laguna i dont think pareho din sila ng sasabihin ng ibang branch...why are they discouraging us?may losses din po ba sila in case na hindi maging maganda ang result ng pag invest?

    ReplyDelete
    Replies
    1. Hello!

      Wow..thank you for your time again for reading one of my posts. ^_^

      Actually, wala naman monetary loss on their part kasi regardless kung kumita o nalugi 'yung investment mo sa kanila, you will still pay them (fees for managing your funds). Ang iniiwasan nila dito most likely is when the investor did not fully understand the investment instrument (which is UITF) and then tries to withdraw their money tapos nagkataon na DOWN ang market. As explained in the article, pag down ang market, chances are your investment will be down or negative too!

      Let's say you've invested 5,000 and when you wanted to withdraw your money, its value based on NAVPU is only 4,500 after a year! If you're the type of client na hindi na-paliwanagan ng mabuti, you'll probably bark at them, right? But if you understand how it really works, then instead of withdrawing, you'll add more investments when the market is down.

      Problem is, most banks fail to explain the subject well. So they simply tell us na "risky" ang UITF investment. And YES, it's true, UITF, like ALL investments including stock market and any business, has its own RISKS. That's why it's best held LONG TERM.

      Hope I got your question right. Thanks and good luck to your future investments! ^_^

      Delete
  8. Nice way to explain it. Well done

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  9. Thanks for giving me an idea where to put my money on the Philippines. I just need to decide now if i will put my money on stock market or mutual funds or UITF.

    ReplyDelete
  10. Hi there, this is very informative and well detailed. I am to glad I stumbled upon your site. I have been searching for any possible investment in the Philippines.
    But I want to ask if how can I be able to join MU while I am currently working here in Canada?
    Hope you can help me answer this and give me some informations. Thank you.

    ReplyDelete
    Replies
    1. Hi,

      You can send me your queries (and email contact) by clicking the "Contact Me" form above (top of this website). I'd be glad to answer them.

      Thanks ^_^

      Delete
  11. this is cool Jeff..- thanks for responding to the e-mail, too.

    Always,
    Mj

    ReplyDelete
  12. AnonymousMay 31, 2015

    sa explanation na 2k ang gain ??mali yata...loss po tayo ng 2116 dahil sa last NAVS ay 3.3949

    ReplyDelete
    Replies
    1. Hi,

      Yes, the last NAVPS bought was at 3.3949, but the computation was based when NAVPS is assumed @ 4.0000:

      There was a supporting explanation right after the table, I think you just missed it:

      *The current NAVPS used for this example is 4.000.*

      Thanks though ^_^

      Delete
  13. AnonymousMay 31, 2015

    27k pesos ang total investment mo .from your explantion kumita ka ng 2K?paano ka kikita eh NAVS mo ay bumba ng 3.3949 pag iminultiply mo sa total share mo na 7300 ay 24884 pesos ang labas ng pera mo!!!.Paki edit lang iyong display column ninyo..Taas taasan mo iyong NAVS para idealistic na nag gain ka...

    ReplyDelete
    Replies
    1. Hi, I'm assuming you're not mad, right? :D

      Anyway, yes, the last NAVPS bought was at 3.3949, BUT the computation was based when NAVPS is assumed @ 4.0000:

      Hence, 7330 (Shares) * 4.0000 (Current NAVPS) = 29320

      So it's a clear gain against your 27,000 investment.

      There was a supporting explanation right after the table, I think you missed it:

      ***The current NAVPS used for this example is 4.000.* **

      Thanks though ^_^

      Delete
  14. Hi Sir! This is very informative for someone who wants to stock her money to MF. My question is, does the monthly additional investment a requirements? what if I am stock with my initial investment of 5000? What could happen? Thank you sir Jeff!

    ReplyDelete
  15. Hi Jessa,

    No, it's up to you if you want to add or not. And if you plan to add, it doesn't need to be on a monthly or any regular basis. It can be daily, weekly, twice a week, once a month, once a year or never. :)

    Thanks for visiting Piso and Beyond! ^_^

    ReplyDelete
  16. Hi Sir,

    Thank you very much for the easy to understand explanation and the reference to the NBA basketball players. :-) , it makes the reading more fun and enjoyable-specially when discussing finance-which by the way is boring for some people.

    Hope you can enlighten me on my question.
    Suppose I want to make ADDITIONAL investment to my INITIAL investment, what date will be used to determine the holding term if and when I want to withdraw, will it be the date of the initial investment?

    Or the additional investment will be treated as a separate investment?

    Thanks.
    Duane Francis

    ReplyDelete
    Replies
    1. Hi Francis,

      Thanks for the warm feedback as well ^_^

      As for your question, yes, your additional investment will be treated as a separate investment (in terms of the holding period), so each investments (Initial & Additional) will carry different holding periods / date.

      Thanks for dropping by :)

      Delete
  17. AnonymousJuly 26, 2015

    Great read as always!

    ReplyDelete
  18. Precy SottoAugust 01, 2015

    Thanks for sharing. 'Learned a lot

    ReplyDelete
  19. Hi Jeff!

    Thank you for taking time expounding about MF in layman. I've been dying to invest through MF.
    Can you recommend companies that perform consistently where can we possibly invest?

    ReplyDelete
  20. Yay!!! ngayon ko ln naintindihan to ang galing ng explanation

    ReplyDelete
  21. Ang galing.. :) Nice Article.

    ReplyDelete
  22. Idol ko yung pg expalian niu Sir jeff.
    Salamat po, mid 20s pa lang po ako pero try ko mag invest sa BDO.

    tanong ko lg po. After 1yr,kung 2k Per month yung iinvest ko, meron bang Charge fee or Ano dian kng d ako mkipag Deposit after 1yr? 5months na d ako mg Dedeposit.. meron bang charge kpg d ka mka deposit per month?

    ReplyDelete
  23. That's a best way to explain about the subject, hat's off team. I have shared the link to 100's of people suggesting to look first. Keep posting .

    ReplyDelete
  24. Good pm.
    Ask ko Lang po... What if nag hulog ka ng 5000. As a starter. Then 1000 . Tapos Hindi mo Na sya nahuhulugan in 5 years.
    May makukuha ka po b nun or wala NA?
    Kumikita p rin ba yun kahit Hindi nahuhulugan.

    ReplyDelete
    Replies
    1. Nandon pa rin po. BUT the amount will be determined based on NAVPS.

      Delete

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