Monday, December 14, 2009

Make your money grow with mutual funds - mutual funds for idiots

Ok I'm still a relative noob with regards to mutual funds. But here's what I have gathered. I use Sunlife mutual funds

If you save money in a savings account or even a time deposit, the interest rate is usually lower than the inflation rate. So if your time deposit makes 5% interest a year, but inflation is 10%, your money lost 5% of its value over the year. You would have been better off buying stuff NOW instead of saving. However mutual funds can have a much higher interest rate.

Mutual funds work like this. Many people invest money then the fund company pools the money until its in the millions of pesos and invests it in the stock market. Not in one stock but several to distribute the risk. If one stock goes bankrupt or suffers a large decline, the others probably wont. So on average, the mix of stocks insulates you from large up or down swings. The mix of stocks used varies with the mutual fund company and the plan you choose. So if the average of all the stocks goes up, you get interest. If the average goes down, then you lose money. The various plans use a different mix of stocks. The more aggressive plans like equity funds buy more volatile stocks, those that can go up or go down a lot.

NAVPS is the term used to refer to the average of all those stocks, this is what you buy. It's equivalent to one "share" in the stock market. The sunlife website updates the NAVPS value daily. If you bought stocks or  NAVPS with a value of say 1 peso each and several years later you sell it when the NAVPS is worth 2 pesos each then you just made 100% interest.

Again, if the stock market goes down the NAVPS value goes down. Thats whats called a paper loss. So what do you do when that happens? If you're a noob you panic and sell, converting the paper loss into a real loss. Real life example based on the past performance of sunlife equity funds. 2007-2008, it went up like 30-40%. 2008-2009, financial crisis, value dropped. So when it dropped, you have a paper loss. If you sold it in mid 2008, your losses would be real. If you were smart you would have held on. By 3rd quarter 2009 more or less, the value of the NAVPS started to recoup all the losses from the crisis so after that, your paper losses start to become paper gains.

So its best to buy when the NAVPS is low, like the crisis last year.

One analogy is that the NAVPS is like buying a mix of say fuel. The diff kinds of gas represent the different stocks. You buy a few hundred liters of fuel. X percent is regular gas, X percent is high octane or premium gas, X percent is biodiesel, etc etc. Although this is an imperfect analogy since the prices of fuel tend to rise and fall together, so lets imagine that all these kinds of gas come from different sources and its possible for the price of one type to go up and the price of one type to go down, i.e. the price change is independent. And lets assume that the fuel does not expire or go stale and there is zero cost to storing the fuel.

In a few years, if the average price of all the liters of fuel increase then you have a paper gain. If the price on average goes down, then you have a paper loss. NOTHING happens as you hold on to the NAVPS. Yo do not earn a yearly interest like a savings account. Your loss or gain only comes when you sell the funds.

With sunlife, the minimum investment is around 5000 pesos. There is a small fee, around 5%. You can pay that up front, its called front end or you can go back end. Back end means you pay the 5% of the initial investment when you cash out. But the back end fees go down  by a few percent every years so by the 6th year its zero.

UPDATE: as you can infer from the 6 year time period, mutual funds are not usually a short term investment. Yes you can sell anytime and you can make money in a short time if you happen to invest right before a large rise in the NAVPS value, however it is usually recommended to hold on to mutual funds for a long time, maybe 5 to 50 years since in the medium and long term, mutual funds consistently earn much more than the inflation rate.

Lets talk about cost averaging.  Most people say its a good idea to do cost averaging. Whats that? It simply means that for example you plan to invest PhP 100,000. Instead of investing it all in one go, you buy php 10,000 worth of funds ten times, say once a month or so. Why is this done? Well this spreads out the risk. If during that 10 months, the increase per month is constant, you would earn more if you invested the 100,000 10 months ago. However if the price of the NAVPS went up and down during that 10 months, your chance of incurring an overall loss is less. Your profit is also less though. Loss of profit is the price you pay to reduce the risk. Plus 100,000 is a large amount, you might not have that much at one time. Every month you just scrimp and save and whatever you save you invest in mutual funds. You do not have to invest the same amount if you do cost averaging. You invest the amount you want, as long as its above the minimum amount accepted by the financial institution.

So you DO NOT have to do cost averaging. You do not have to invest so and so thousands of pesos every month or some other interval. You can invest the 100,000 all in one go if you like and forget all about the funds for the next 10-50 years. Of course the risk is higher.

UPDATE: unlike time deposits and like plain old stocks, you can sell anytime. Of course if you chose the back end option and it is less than 6 years, you pay the corresponding fee.

Its been a little over a month and my navps has gone up from 1.79 to 1.8x. Around 3% a month. Not bad. According the historical records, since jan 2009, the increase was like 40% for my sunlife equity fund. Here's my agent's email.To start investing in mutual funds once you understand all the advantages and disadvantages compared to other types of investment, then contact your nearest mutual funds office or use the email above. AFAIK you HAVE TO get an agent (at least for sun life), you cannot deal directly with the office.

UPDATE: its been 11 months and my sunlife paper profit is around 36%. Not bad. I added the fuel analogy and a discussion on cost averaging.

UPDATE: Payment
When it comes to payment I recommend you pay directly to the office to be 100% sure the money gets there and the agent does not abscond with the money. Its an over the counter transaction.You can pay in cash but that is risky. Sunlife does not accept credit cards or paypal AFAIK. You can pay with a check or manager's check but I just transferred funds from my savings account (BPI) to their savings account. The list of compatible banks plus their account numbers is printed on the back of their forms. That way you are 100% sure that a scammer cannot give you a different account number

UPDATE: Documents needed
1. xerox of valid ID's with picture
2. if you pay via their bank account, you need a xerox copy of the deposit slip from the bank. The original is for the office, the xerox is for you.

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