Risks for mutual funds

In my May 13 blog, there were significant comments related to the risks of Mutual Funds (MF) and Unit Investment Trust Funds (UITF) specifically on the need to understand risks. I could not agree more with the comment that one should not just follow without understanding the risks. In fact, in my first book, “Wealth Within Your Reach,” one principle I emphasize is “Seek Professional and Expert Advice.” However, I do not agree with the comment that, in analyzing, negatives should come before positives. What is more important is to first have a specific financial goal in an absolute amount over a specific and definite time period It is only when you have such a clear and definitive target that you will be able to assess the level of risks you must take to reach that targeted amount. Without that amount and time period, there is no way for you to identify and evaluate the odds or risks in achieving your goal. Once you have set such a target, assessing the pros and cons go hand in hand. And, in assessing the negatives, understand why they are negatives and how you can therefore reduce their influence. A blog, by its very nature, cannot be all encompassing. This is why I emphasize that people who need to clarify anything can email us for more information. Before talking about the risks in MF and UITF, you must understand that there will be fluctuations in the value of the MF and UITF Net Asset Value or NAV. NAV is the computation of the value of each unit share based on the market value of all the investments in the portfolio of each MF and UITF. A MF and UITF can be likened to a basket of many fruits that a group of friends bought by contributing the amounts of money they could afford. Here, the underlying assets that support the value are the quality and quantity of the fruits in the basket. There are a different number of pieces of each fruit in the basket and each has a different value. But the friends want to know how much their ownership is in the basket of fruits because each of them contributed a different amount to buy the fruits. In the same way, each MF or UITF is made up of different financial assets in varying quality and quantity. This is what makes the specific MF or UITF desirable or not. The composition of the financial assets in the Fund is determined and decided upon by the Fund Manager. This is why we always say that you should pay close attention to the character and strategy adopted by the Fund manager of the MF or UITF you are invested in. The process of computing the NAV can be likened to being able to compute the ownership of each friend in the basket according to the amount of money he contributed. It is a mathematical process that is accepted worldwide by all financial institutions. The NAVs of MFs are published daily in newspapers and websites. The NAVs of UITFs are published in the website of the bank offering the NAV. Let me now clarify what I mean by risk. Everything has a risk including your life. Each minute of your life here on earth, there is the risk that you can die. The lowest risk is when you are born without any problem whatsoever. The risk of dying increases, as you grow older because we will all die. Your risk of dying increases if you have a disease, if your job is dangerous, if the place where you live or work is dangerous, etc. It is the same with investment risks. There are risks in all investments and the least risk is in Government Securities. The higher risks are in putting up your own business particularly if you do not really know or have a passion for the business. Directly investing in the stock market if you are not technically knowledgeable and/or investing in properties and products that are questionable or are beyond what you can afford will certainly result in capital losses. This is because you can lose all the capital you invest. The higher the risk, the higher the return. The lower the risk, the lower the return. While there are risks in MF and UITF, the real risk lies if you make the investment for a short time period only. The greatest mitigator of risk is TIME, not TIMING. Thus, you can take bigger risks if you have much time available to achieve a specific financial goal. This also means that because you are expecting a higher return, the amount you need to invest will be smaller compared to targeting the same amount of financial goal but over a shorter period of time. The NAVs go up and down over short periods but in long periods like three to five years, the NAV levels are increasing. So you can reduce the risk of losing value by being prepared to keep your money invested for at least three (3) to five (5) years. This is one way of controlling the risk in possible reduction in NAV value. When the NAV fluctuates, you should not panic. As long as you do not sell, you have not lost any money and the NAV will eventually improve. The moment you sell at a loss, your loss is permanent. You must also remember that MF and UITF do not give interest or dividends. You get your money back only when you sell your shares. The difference between your buying NAV and your selling NAV is your profit or your loss. You must choose to sell when the NAV is high enough for the returns to be acceptable to you. There are three types of MF and UITF. Equity or Stock Fund, Fixed-income or Bond Fund and Balanced Fund. An Equity Fund is mostly invested in the stock market and therefore offers higher gains but is also more risky A Fixed-income Fund or Bond Fund is mostly invested in government securities and other fixed-income securities and therefore offers modest returns because it is less risky. A balanced fund is where half of the fund is invested in the stock market and the other half is invested in bond or fixed-income funds. The returns here would be moderate but so also is the risk. It is best to always spread your risks. Do not put all your savings in one type of investment or in one company. You choose the risk that is best for your own financial plan. When you start saving and investing early in your life, you can take the bigger risks and therefore, have the chance to earn higher income from your investments. If you make a mistake in taking the bigger risk and losing the income that you were looking forward to, you still have the time to recover. It is just a matter of making a clear personal financial plan and strategy to reach your objectives. Unfortunately, if you are advanced in age and have not planned for your retirement when you were young, the automatic tendency is to want to make up for lost time and choose the high income potential even if the risk is very big. That is a big mistake. Making high-risk investments at your old age is pure gambling. In MF at UITF, you should also spread your risks. Choose to invest only from the top ten best managed and best earning funds. And, if you have enough savings, choose to invest in different types. For example, do not choose all equity funds or all fixed-income funds or all balanced funds. Spread your risks by putting a part in equities, part in fixed-income and part in balanced funds. Again, how you distribute your investments will depend on how much you want to accumulate over a specific amount of time. I will take up the advantages and disadvantages of investing in a condo in my next blog. This was a significant comment in the May 13 blog. FRANCISCO J. COLAYCO is an entrepreneur, a venture developer and financial advisor. He has over 40 years of experience that covers service contracting in the Middle East, manufacturing, trading construction, shipbuilding, management consulting, banking and financial services. He is the Chairman of the Colayco Foundation for Education (CFE) and the author of bestsellers: Wealth Within Your Reach (2004 National Book Award for Business and Economics), Making Your Money Work (Nominated in 2005, National Book Awards Business and Economics), Pera Palaguin Workbook and Money for Kids. The books are available at National Bookstore, most other bookstores or directly from CFE. He joins our website blog to share with ordinary income earners, Overseas Filipino Workers (OFW) and students the simple principles to "Save what you earn and grow what you save." CFE conducts talks, seminars, and workshops. “Managing Personal Finances For The Future” a seminar-workshop developed in partnership with the Ateneo Graduate School of Business, Center for Continuing Education. June 21, 2008, Saturday, 9:00 am to 6:00 pm. For registration and inquiries, please call Marleth Calanog at 830-2050. CFE is also the producer of the PISObilities DVD series, available at your favorite audio-video shops in May 2008. Learn more about the advocacy at www.colaycofoundation.com, email info@colaycofoundation.com, via SMS +63917-8537333 or through (632)637-3741.