A Mutual Fund is an investment company that pools money from different investors and allocates that money into different classes of investment vehicles such as stocks, bonds and cash or cash equivalents depending on the investment objective of the fund. In the Philippines Mutual Funds are set-up as open-end investment corporations owned by its shareholders and managed by a professional called Fund Manager who oversees the direction of the Fund.
Call this article Mutual Funds 101. This is our first introduction to the fundamentals of Mutual Funds in the Philippine setting.
But before going any further, let’s review first what we’ve learned about Corporate Bonds, Stocks and Government Securities and elaborate on those concepts a little bit. Plus, let’s also discuss the ideas behind Cash and Cash Equivalents as savings and investment instruments.
Cash and Cash Equivalents
This is the easiest to understand of all the Asset Classes. As a matter of fact, I personally don’t consider it investment at all, but simply as savings product.
If you have money in the bank — and we all have — in the form of ATM Accounts, Passbook Savings, Checking Account or even Time Deposits, then you already know what Cash means. Sometimes we confuse cash with money. But money is simply a medium of exchange that can take many forms: line of credit, credit cards (aka plastic money), bit coin (a digital currency), land, or anything of value.
Cash is the most liquid of all the asset classes. So if your husband has lots of cash, I’m afraid your relationship may not be that solid… It could be liquid. 🙂
Cash Equivalents on the other hand, refers to things like
- Bank Certificates or Deposits like Time Deposit and Special Deposit Accounts
- Commercial Paper
- Money Market Instruments
- Treasury Bills (short-term loans to the Philippine Government)
- Commercial Paper (short-term loans to corporations)
Cash and Cash Equivalents should have a place in everyone’s investment portfolio. They are good for:
- Temporarily parking your money.
- Setting up an Emergency Fund.
- Depository funds for business operations where cash flow is important.
They are considered as fixed-income instruments because they offer fixed rate of return. As investments, they belong to the low-risk category and low return, as well.
Q: How do you earn or make money from Cash or Cash Equivalents?
A: Through the interest.
( See also: 3 Things You Can Do With Your Money )
Corporate Bonds and Government Securities
Bonds are simply debt instruments issued by either the government or corporations (borrowers) to the bondholders (the lenders). Bonds are interest-bearing loans, which pay out a fixed rate of interest and for a specific period of time and return the original loan at maturity date.
Like the Cash Equivalents, bonds are also considered as fixed-income instruments. The main difference between the two asset classes is that cash is normally short-term (less than 1 year) while bond could span longer than 1 year to as long as 100 years!
Q: How to make money in bonds?
A: From interest payments and by trading bonds.
Yes, bonds can be traded just like common stocks.
Investment Tip: Investors who are risk averse or conservative should have a majority of their asset allocated to Bonds and Cash Equivalents. With these types of securities, Capital Preservation is the name of the game.
( See also: T-Bills and T-Bonds, The Two Types of Government Securities in the Philippines )
Stocks or Equities
Stocks (sometimes called Equities) represent an ownership stake in a corporation. If you are a stockholder, you are also a part-owner of the company.
There are basically two flavors of stocks:
Preferred Stocks
- has no voting rights
- almost similar to bonds in that it pays fixed dividends (bonds pay fixed interest) to the owner
- has higher priority than common shares in terms of dividends and claims over the assets of the company when it is liquidated.
Common Stocks
- has voting rights
- may earn dividends
- share values may rise and fall depending on the outlook of the business
Common Stocks are more exciting than preferred stocks. Common Stocks also offer the greatest income potential when the business succeeds in its ventures!
When investors refer to the term “stock”, they normally mean common stock.
Q: How do you make money in stocks?
A: With shares of stock, you can make money in two ways:
- through dividends — when the company gives them out and distributes them to shareholders.
- through capital gains — that is, by selling your shares at a higher price than you bought them.
( Good to know: How Companies Raise Capital and How To Make Money From That )
Ready to Invest in Stocks and Bonds?
You may think that investing in Bonds and Stocks are pretty exciting, but here’s the catch: to really strike it rich by directly investing in Stocks and Bonds, you need a big amount of money.
And by big amount, I’m talking about at least P 5 million as play money. Otherwise, skip it altogether.
Take note of the words I’m using: big amount, play money.
Well, that’s something our local Financial Gurus in the Philippines don’t want you to know.
They would say something along these lines:
“My maid invests in stocks and you too can do it.”
Really? Does she (the “maid”) know about EPS, P/E Ratio, the LIBOR rate, Systematic risks, and all that stuff?
“Buy shares XYZ Corporation! Even if it’s down the sink at the moment, with lots of prayers and God willing, it would rebound again. Alleluia!”
But until when should you hold on with that shares? Until the Second Coming? Or, did your so called “stock expert” already unloaded his shares from XYZ Corporation he just didn’t tell you yet? How would you know you are simply taken for a ride?
“Double your money in 6 months with this HYIP.”
Hahah!
I’ve scratched my head for dandruff countless times already every time I see our fellow Filipinos fall into these traps.
One of the fundamental rules of investing is to understand what you are getting into.
As a matter of fact, I always warn my clients against investing in something they don’t understand, especially if it involves a lot of complicated jargon.
I pity the guy who invests in stocks directly — picking companies based on their names, just like they do during political elections — without first learning the fundamentals or even asking if there are alternative investments.
Not you.
If you are reading this far, you are now in a better position than the rest of your friends who are investing blindly based on tips from Financial Gurus who only prey on the stupidity and naivety of their flock.
In Part Two of this series, we’ll learn about the fundamentals of Mutual Funds and why investors like you should take a look at this investment vehicle and familiarize it thoroughly.
