D.  Gift Money:

As you go higher in the hierarchy of needs, you develop a need to provide for people or causes that you care deeply for.  This could be some kind of charitable institution or foundation or some family member that you want to take care of.  But the most common use for gift money is to provide for education.  Saving for education early on through long-term vehicles like mutual funds, note and bonds, or trust products, will make it more efficient and easier on the pocket.  Another typical example for this type of financial need is the desire of parents to leave a reasonable amount of estate for their children.  Again, this can be accomplished through long-term instruments.  For people whose investment horizon is short or those who may not have enough resources to accumulate a substantial estate, the best way to create one instantly is to buy life insurance.  On the other hand, for rich individuals who are more concerned with the inheritance taxes that their heirs will need to pay for, a good solution is to get a life insurance coverage equivalent to the taxes that will be incurred by their heirs.

 E.  Dream Money:

Dream money pertains to funds that you need to have for all the things that you dream of being, having, or doing.  These goals can pertain to your retirement, or the kind of lifestyle you want before or after retirement.  Normally these are funds that you will need after you have gone beyond your peak income years.  Therefore, these types of needs will require large amounts of monies.  Long-term vehicles like mutual funds, note or bonds are the best instruments for establishing your nest eggs for this purpose.  While more and more people are becoming aware of the need to save for retirement, very few people realize that a big portion of their retirement funds will be spent on medical needs.  In this regard, it is prudent to set aside funds specifically for the purpose of funding for medical expenses after retirement.

Having a structured approach in prioritizing goals will enable you to build an investment portfolio that’s tailor-fit to your needs and your available resources as well.  The important thing to remember in using this approach is that you need to establish (and maintain) your lower-end targets before going for the higher goals. Having a strong base results to a stable portfolio and keeps you away from situations where you are force to liquidated long-term placements in order to meet an immediate financial obligation.

For example, buying garments on wholesale and then selling them retail at a good mark-up in your local neighborhood bazaar has its risks.  You may not be able to sell everything, and at the price you hoped to get.   But maybe the possible profits that you could make are worth the risks that you’re taking. That’s entrepreneurship for you.  Or you could be buying insurance from a reputable firm, then suddenly discover one day that that insurance firm itself is going bankrupt.

No investment is perfectly predictable.  Therefore, even good investments have a certain amount of risk involved.  If no one ever took any risks, then there would be no economic progress at all.  The key is to anticipate the risks, and manage the investment so that the risks are reasonable compared to the return that you expect to make. 

It’s all a matter of risk-return tradeoffs.  The higher the risk involved, the higher should you demand the returns/profits to be; otherwise you will not make the investment.

Some suggestions

Usually, when making an investment, you are attracted by the possible returns that you could make from that investment.  Most likely, you would compute potential profits, given realistic, but favorable conditions.  You could also compute potential profits should your luck really be good (assuming the return is not fixed).  Don’t get blinded by these computations, though, but seek another person’s opinion (someone whom you consider wise and unbiased), to make sure that your assumptions make sense.  Many people have been fooled by scams and swindlers who present seemingly realistic, easy-money promises, and who take advantage of an investor’s ignorance and greed.

But you shouldn’t stop there.  Before making any investment, it would be wise to anticipate and predict a “worse case” scenario to see how much you would lose, or how low your profits would go, in case something negative happens that you didn’t expect.  With a little calculation, you can determine your break-even points, and compute your remaining profits (or losses), given those worse-case situations.   Again, it helps to seek the counsel of a third-party, someone who has no stake in the investment, and certainly not the person who’s selling you the investment, to help you assess the various downside scenarios, and give you a reality check.

Then you should weigh the pros and cons of these various situations, and the likelihood of occurrence of each of these.  If the upside is likely, but the profits are not so fantastic, compared to the losses that you might incur if the downside occurs, then you would probably decide that “it’s not worth the risk.”  On the other hand, if the upside, though not so likely, is very attractive compared to the danger of losing in a downturn, then you will decide that “it’s a good investment.”

In a future blog, we will continue this discussion on risks to see lessons from the past.

[page_stats]

A mutual fund is a company whose capital is invested by a professional fund manager in investment-grade instruments like stocks, bonds, and so on.  If you invest in a mutual fund, you’re buying shares of that company, and your money is included in the pool of capital that is being invested by the fund manager.  The price of buying (or selling back) your shares is based on the market value of the investments of the company at that time.

The job of a fund manager is to maximize the value of the fund while taking into account the risks involved.  Your investment will go up (or down) in value, depending on how profitable those investments are which the fund manager is making on a day to day basis.  Everyday, the value of your capital is computed based on how much money the fund manager made, or how much worth the investments are in the market at the end of the day.

Your investment in a mutual fund does not earn a fixed interest; instead you earn money when you sell back your shares at a price, or value, that is higher than when you bought those shares. 

There are risks involved in investing in mutual funds.  The value of your funds could temporarily be down from the time you purchased it, depending on capital market situations, and depending on the kind of mutual fund it is.  A bond fund (invested in the bond market) does not fluctuate in value as quickly and as dramatically as an equity fund (invested in the stock market).  On the other hand, a bond fund does not increase in value as fast as an equity fund.

You may withdraw your investment, or sell back your shares, in a mutual fund anytime you wish or need the funds.  You may, however, end up losing money when you sell at a time when the values are declining.  In the long run, say, more than two to three years, the value of a mutual fund improves at a rate much higher than if you were investing in specific individual savings or investment instruments yourself.

Note: There is a print link embedded within this post, please visit this post to print it.

So how do you differentiate yourself from a fund manager? – Basically you come up with answers to the same three questions (what . . . , when . . . ., and how much . . .) using different means.

What to Buy or Sell

In answering the question “what to buy or sell”, most fund managers use fundamental factors, technical indicators and mathematical tools.  As an investor all you need to do to answer this question is to set your goals (retirement, college funding, capital for business, etc.) and to know your risk appetite (aggressive, moderate, conservative). 

When to Buy or Sell

To answer the question “when”, a fund manager again uses many tools (mathematical, cyclical, trend followers, etc.).  To accomplish the same feat as an investor, what you need to do is to determine how much time you have to invest (this is almost automatically determined once the goals are set) and what resources you have available for investing (how much of your monthly salary can you set aside for investing?).  For an investor like you there is only on answer to this question – NOW.  Your success as an investor will not be a matter of timing but of how much time you have to invest.  So start early!

How Much to Risk

Finally in order to manage risk effectively as an investor, you don’t need all those ratios, alphas, betas, audits and what have you that fund managers use to evaluate risk. All you need to do is to choose the right fund and the right fund manager.  Nowadays with all the scams going around choosing the right fund manager is almost as important as choosing the right fund.  Once you have accomplished the first two steps you will realize that choosing the type of fund is best for you will be easy enough because you already know what type of returns (professional financial planners can help you determine this)  to look for in order to meet a specific goal. 

So, to develop that winning investor’s mindset just remember these four simple phrases:

1. You are not a FUND MANAGER! Think Like an INVESTOR
2. Know your GOALS (put them on paper) and RISK APPETITE.
3. Determine how much TIME you have to invest for each goal (the longer the better so start early).
4. Choose the RIGHT FUND, and the RIGHT FUND MANAGER.

Here is a typical telephone conversation between an investment solicitor/banker (Jill not her real name) and a prospective investor (aka Mr. Belle not his real name either). 

Phone rings…

Jill:  Hello, May speak to Mr. Belle please?

Mr. Belle:  This is he.  Who is this please?

Jill:  Good morning Mr. Belle.  This is Jill from JMC-Duart Investments, and I’m calling to ask if it is possible to see you in person regarding an investment proposition.

Mr. Belle:  What kind of investment are you carrying?

 Jill:  JMC-Duart is principal distributor for an assortment of mutual funds that have varying degrees of risk and potential returns.

Mr. Belle:    I already have mutual funds.  What is the average return on your stock fund?

Jill:  In the last three years our equity fund has averaged over 16% net for shareholders.

Mr. Belle:  Hmmm, that’s quite impressive but the market is really bad right now so I don’t think this is the best time to get into equities.  In fact, just recently, I decided to redeem my equity mutual fund shares to limit my losses.  The fundamentals are bad and the technical indicators are not very promising either.  I don’t want fixed-income investments either because interest rates are currently too low.  Call in a couple of months.  If the timing is right, I might consider meeting with you to find out more about your funds.

What went on during the conversation?  Well, in a nutshell, Jill tried to sell Mr. Belle mutual fund shares but Mr. Belle felt that the timing is not right.  Furthermore, Mr. Belle is an aggressive investor and considers only high yielding investment. He is also the type of investor who prefers to manage his own investment portfolio.

And what does Mr. Belle do for a living?  He sounds like a banker, an investment officer, perhaps a stock broker or maybe he is a fund manager.  Actually, Mr. Belle is a BALLET INSTRUCTOR.  He knows a lot of the investment jargons because he is genuinely interested in investments so he reads a lot.  But does that make him a professional fund manager?  Not quite.

A fund manager is a different kind of animal (no pun intended).  Upon waking up in the morning a fund manager would look for the morning paper before his sleepers so he can catch up on anything that might have happened while he was asleep.  He or she will have breakfast while reading the business section, somehow be able to take a shower while still reading, and drive to work still reading the paper (Don’t Try This at Home).  The only time he lets go of the morning paper is when gets to the office and he comes face-to-face with his best friend in whole wide world – his Bloomberg terminal. He then spends the whole day in front of the monitor to watch the markets go up and down, up and down, . . . . .  up and down all day long.  After work, he goes home, has dinner, maybe a couple of drinks and goes to sleep.  While asleep he will dream of the markets going up and down, up and down, . . . .up and down all night long.

 I am of course exaggerating.  My point is this.  A fund manager eats, sleeps, breaths, and lives in the markets.  He is capable of doing things with the markets that ordinary people can not do – like shoot an order to buy or sell a security at the snap of a finger (or at a click of a button if he or she does not have an assistant) and more importantly, stay emotionally unattached to the markets.

So if you are NOT a fund manager by profession then don’t fall into the trap of trying to think like one.  The best thing for you to do is to THINK LIKE AN INVESTOR and let your fund manager do his job.      

To be continued . . .

 Can PCA Improve A Current Losing Position?

Earlier, we illustrated that PCA can reduce your average buying price as long as you are able to buy more shares at lower prices.  Therefore, PCA can improve your losing position by pulling the average buying prices below the original.  Hence, a 3% improvement can be attained by lowering your average price by 3%.

 Therefore, in principle, PCA can improve your current losing position.  But there is a catch though.  One, you need additional capital to pull this off.  And two, the additional amounts in total must be significant enough to even make a dent on your original lump sum investment. 

Say you invested P200,000 at the start of the year in a mutual fund that has a price per share (NAVPS) of P10.  Assuming no fees are charged, you were able to purchase 20,000 shares.  Unfortunately the price started going down for six straight months with no signs of reversing.  After six months you found your  investment losing by 20% as the price hit P8/share.  You decided to apply PCA for the second half of the year by investing P10,000 at the start of each month for the next six months.   

An evaluation of your investment strategy shows the following results:

• You invested an additional P60,000 (+30%) to perform PCA.
• With PCA you were able to add 7,966 shares (+40%) to you original 20,000 shares.
• The result of being able to buy more shares at lower prices reduced your average price from P10/share to P9.29/share.
• As a result of the lower average price, you managed to improve your overall investment performance from a -20% to -14% when the price ended the year at P8/share.

Aren’t you just throwing away good money after bad with PCA?

Not at all!  As illustrated earlier, PCA can work regardless of whether you are investing fresh funds or just adding to your currently losing investment to average down your price.  As mentioned earlier, PCA is not a perfect system.  It does have its pitfalls particularly in terms of opportunity losses.  Other approaches like Value Averaging may, perhaps, be more effective in certain market conditions.  However, if you are comfortable with a simple, easy-to-implement, and light-on-the-wallet type of approach then by all means do PCA and stick to it.

Warren Buffet suggested that the best holding period is forever.  For the short-term investors looking to make a fast buck, PCA is probably not your cup of tea.  But if you are a conservative, long-term investor, with a buy and hold strategy, this may just be the edge that you need to turn the current crisis into an opportunity to surpass your investment goals.

In Scenario 2 the mutual fund price drops from P10/share to P3/share.  In the lump sum style of investing where P1,200 bought 120 shares at P10/share, the value would be P360 in December.  Through PCA we were able to buy 266 shares because of the declining price and therefore will have an investment value of P798 in December.  However, because of the big drop in the price of the mutual fund shares, bought styles lost money (-70% for lump sum; -34% for PCA) but PCA was able to minimize the loss.

So does this mean that PCA will always outperform lump sum investing?  Not really!  PCA is by no means a “cure-all” approach.  In a market that steadily goes up, lump sum investing will generate more returns than PCA.  In a third market scenario where the price steadily went up from P10/share to P20/share, PCA would have resulted to a purchase of only 82 shares.  Therefore our investment value at P20/share (December) would have been P1,640 for PCA versus the P2,400 in the lump sum approach.

Hence, the ugly side of PCA is that there can be opportunity loss in extremely good (or bullish) markets.

Let us weigh our options.  In good markets PCA can result to higher returns provided that there is some volatility in the prices that will enable us to buy more shares.  With out the volatility, then we earn less (but we still earn).  Aside from deposits, what other investments have zero volatility? – The answer is none.  On the other hand, PCA reduces the risk and consequently the losses during bad markets.  So in a nutshell PCA means reduced risk, with possibly higher returns, but not without possible opportunity loss.  Sounds like a pretty good deal doesn’t it?

To be continued . . .

What is Peso Cost Averaging (PCA)?

Peso-cost averaging (referred to as dollar cost averaging in the US and pound cost averaging in the UK for obvious reasons) is done by simply investing a fixed peso amount into your mutual fund (or other investment instrument) at pre-determined intervals (normally less than a year – monthly, quarterly, etc) . The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per peso invested due to the higher cost per share. When the markets are down, the situation is reversed and you purchase a greater of number of shares per peso invested. It’s a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you don’t have to invest the time and effort to monitor market movements and strategically time your investments.  While the effectiveness of the concept has been debated on for decades now, even the skeptics agree that the PCA does really reduce risk and avoid the possibility of “investing all the money at a market high”.

To illustrate PCA let us consider three market scenarios and two investing styles per scenario.  The first investing style is the typical lump sum investing where you invest all your money on one price and wait for the price to go up.  The other style of course is PCA.  To simplify our calculations let us say that we have P1,200 to invest over a one year period. 

 In our first market scenario the price of the mutual fund moved from P10/share to P5/share and then to 20/share (over the one year period).  In lump sum investing, our P1,200 can purchase 120 shares at P10/sharein January.  Hence, at the price of P20/share in December, the 120 shares that we bought has a total value of P2,400.00. By applying PCA where we invest P100 at the start of each month (for 12 months) we can purchase 136 shares (16 more than the lump sum strategy).  This is similar to a lump sum investment of P1,200 at a lower weighted average price (P8.80/share). This means that the value of our investment in December at P20/share is P2,720.00.

To be continued …

1.  Start Early

The only way you can make the most out of the limited time you have is to start early.  The sooner you invest, the more time your money will have for growth. If you delay, you will almost certainly have to invest much more to achieve a similar result.  Let the power of compounding work for you.

2. Keep Some Cash Aside

It is always a good idea to have some money set aside in case of emergencies. Maintaining three to six months worth of living expenses will insulate you from a sure fire formula for investment loss – distress selling. 

 3. Know Your Risk Profile

What is the point of investing in the stock market if you are going to lose sleep, if you don’t get a heart attack first, every time prices go through a rough patch. You need to be realistic about your risk appetite.  An investment advisor can help you determine your tolerance for risk.

 4. Never Forget About Inflation

Don’t fall into the false sense of security that very conservative investments might give you.  The returns may look respectable at the start but not after you deduct the effects of inflation.  Keep in mind that risk is not just about losing money.  It is also about not having enough in the end.

 5, Think Carefully About How Long You Can Stay Invested

If you plan to stay invested for a long period of time, say five years or more, then it is okay to go into the stock market and let your money work harder for you.  But if you will need your funds very soon, you are going to be better off with low risk investments.

 6. Spread Your Money Across Investments

Don’t put all your eggs in one basket.  Depending on your goals and attitude to risk, you will probably want to spread your money across different types of investment – equities, bonds and cash. You may also want to diversify within each of these categories. An equity fund, for example, will invest your money in a variety of companies but you may want to ensure you have a range of industry sectors too.

 7. Invest Regularly

Investing regularly can be a great way to build up a significant lump sum. You will also benefit from what is known as cost averaging. In this way you hardly feel the pain caused by delayed gratification since you are saving small amounts that you can easily afford. 

 8. Choose Your Funds Carefully

You should select investments based on your personal circumstances and goals. Don’t assume all funds investing in equities are the same – look at what a fund invests in and check if you are comfortable with its investment style and objectives.  Choosing the right fund manager is nearly as important as choosing the right fund.

 9. Remember That Time and Not Timing Is The Key To Successful Investing

Even the most experienced fund managers fail when it comes to timing the markets.  As an investor your concern should be to have as much time as possible to stay invested.  Take the long-term view and stay in a fund that you are comfortable with for as long as necessary.

 10. Review Your Investment Regularly

There are a number of reasons why you might need to change your investment portfolio.  Your goals might have changed over time or your resources might have changed significantly.  Whatever the reason may be, your life stage will play a vital role in determining the right investment mix for you.  It is prudent to review your investment once or twice a year at the very least to determine if you are still on track to hitting your goals.