That is an actual question I received from a website visitor some days past.
The truth is, I always get similar questions every time I introduce the concepts of Mutual Fund Investment to a potential client or a friend, who happen to have no background whatsoever in Securities Investments. What I noticed is, their question always revolve around the concept of interest rate.
It’s understandable because Filipinos are all too familiar with the concept of interest earnings.
Did you know that apart from interest, there are other ways to earn in an investment?
It is my hope that after reading this article, you’ll be able to answer the question posted in the title and that you’ll gain a better understanding of how to grow your money in a Mutual Fund.
Let’s start off by first exploring the other ways of growing your money in an investment.
The 3 Ways to Earn in Any Investment
1. Through Interest.
Interest is very easy to understand. Your Savings Account and Time Deposit with the bank earn you a guaranteed annual interest. The way your money earns here is dependent on two factors: interest rate and time.
The mathematical formula to determine simple interest is expressed this way:
I = Prt
where I is the Interest; P is the principal investment; r is the interest rate (usually expressed in percentage form) and t is the time.
Its so simple, sometimes you can even do mental math on some numbers to compute how much your money will earn at a given period of time.
Money in the bank, of course, earns compound interest; which simply means interest earning more interest.
The good thing about earning through interest is that your earnings are highly predictable. There are no surprises along the way.
Examples of Investments that earn interest:
2. Through Dividend.
The way to earn dividends is by owning shares of common stock in a company. Dividend is money derived from a portion of the company’s earnings distributed to its shareholders (owners of common shares).
Dividend distribution is usually quarterly, semi-annually or annually and has to be decided by the corporate board of directors. In other words, dividend pay-outs are not guaranteed and you can’t tell in advance how much exactly you will earn.
3. Through Capital Gain.
Investopedia.com offers a clear definition of Capital Gain this way: “An increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold.”
For example, if you bought a piece of real estate at P 10 M and you later sold it for P 12M, your realized capital gain is P 2M. Take note that the only way to earn here is by unloading or selling your investment.
So, How Do You Earn From a Mutual Fund Investment?
First, you need to understand that Mutual Funds are composed of different types of securities, the three biggest asset classes of which are: Cash Equivalents, Bonds, and Stocks. Each of this types of investments have different modes of earnings.
- Cash Equivalents and Bonds earn interest. That is why, they are sometimes categorized as Fixed Income Securities.
- Stocks, on the other hand, earn through dividends and capital gains.
Second, bear in mind that Mutual Funds are diversified investments — bonds from different companies, various government security issues, share holdings from many corporations, etc. What this means to the overall value of the fund is this:
- Different Bonds, T-Bills, T-Notes will have different interest (or coupon) payment schedules.
- Stockholdings from different companies may perform differently
- Some companies may pay dividends, others may not.
The moment you understand these things, it becomes clear why earnings in a Mutual Fund is not predictable, unlike your earnings in a Time Deposit or Bank Deposit Accounts.
Time Deposit Is Guaranteed! So, Why Bother With Mutual Funds?
I’m sorry to tell you this, but if you can’t see the problem with Time Deposit, Savings Account, and other forms of Cash Equivalents, the following statements may describe you:
- You are financially blind.
- You have no idea about the rate of inflation.
- You don’t know what the tax rate is on your interest earnings
Earning a guaranteed fixed rate is a game played only by the Financial Losers.
Robert Kiyosaki (I hate that guy) said it best: “Savers are losers!”
Here are the problems inherent with interest-bearing investments:
- They can’t beat inflation.
- They are taxed the most.
- They are not designed for maximum earnings.
If you are investing for retirement or building a college fund for your kids, even the highest interest-bearing Time Deposit in the market just won’t make it. The illustration in the next section will show you why.
Time Deposit vs Mutual Funds
Here is a comparison of a Time Deposit Investment performance versus the two Mutual Funds from the Philam Asset Management Incorporated (PAMI).
- PBF stands for Philam Bond Fund. It consists mostly of government securities and local corporate bonds.
- PSGF stands for Philam Strategic Growth Fund. This is PAMI’s Equities Fund consisting mostly of common shareholdings from Blue Chip and other big corporations in the Philippines.
For simplicity, the illustration above assumes the following:
- P 10 million investment started in the January 2001.
- 6% annual interest rate for the Time Deposit. In reality you could be given less than that.
- A tax-free return on the Time Deposit.
As for the two mutual funds – Philam Bond Fund and Philam Strategic Growth Fund – the rate of returns shown here are actual returns for the given years covering the period 2001 to 2010. I’m not making this up. These are actual and documented figures, monitored by third-party companies like Bloomberg.com.
Conclusion — At the end of the 10-year investment period:
- Time Deposit — yielded 79.08% total return or P 7,908,476.97
- Philam Bond Fund — yielded 120.47% total return or P 12,046,842.95.
- Philam Strategic Growth Fund — yielded 316.47% total return or P 82,979,799.24.
Now, let’s try another example and trim down the figure to, say P 20,000 initial investment. I think, that’s easier to digest. At the end of the 10-year period, your P 20k investment would have earned you:
- P 15,816.95 in Time Deposit.
- P 24,093.69 in Philam Bond Fund.
- P 165,959.60 in Philam Strategic Growth Fund.
And the Million-Peso Question is:
Which is Better: Time Deposit or Mutual Fund?
If your answer is Mutual Fund, I’m telling you — “You Still Don’t Get It!”
In another article, I will be showing you the right way to approach a mutual fund investment and equip you with the right attitude in making this type of investment.
Meanwhile, I encourage you to read again the article and try to really understand the concepts presented here. If you have some questions, feel free to drop me a message using the Contact Form. I always love to hear from visitors like you.