Should you invest in Mutual Funds?

What is a Mutual Fund?

It is a company that pools money from many investors and invests them in different types of assets such as stocks, securities, bonds etc. The company takes the pain off investors on figuring out where to put their money by professionally managing the pooled money. Investors buy shares from the Mutual Fund.

In the Philippines, we also have Unit Investment Trust Funds (UITF). They are similar and the major difference is who regulates what. UITFs are regulated by the Banko Sentral ng Pilipinas (BSP) while Mutual Funds are under the Security Exchange Commission (SEC). UITFs are also offered by Banks while MFs by investment/insurance companies.

How do you make money from a mutual fund?

You can make money via capital gains, similar to how you gain/lose money from a stock. For example, you bought 100 shares from a Mutual fund for ₱60/share. That's equal to ₱6,000 (₱60/share X 100 shares). If you sold your share at 100 pesos/share, the total market value of your shares is at ₱10,000 (₱100 X 100 shares)-- that means you have a total gain of ₱4,000 (₱10,000-₱6,000).

Some funds also pay dividends. Dividends are earnings of the company and commonly distributed in the form of additional shares or cash to shareholders. It's usually a certain amount per share. Dividends are normally reinvested by the company, in your behalf.

What are Passively Managed Funds?

These are funds that don't require a team of experts to do some research about where to invest. These usually just follow a market index which captures the average return of a particular market. Because of that, it has much lower fees than actively managed ones. One good example of this is, PhilEquity PSE Index Fund (XPEIF) which tracks the Philippine Stock Exchange index (PSEi). PSEi consists of top 30 publicly-traded companies with computed weighted mean. XPEIF's management fee is currently at 1%.

There's another type of fund similar to a Mutual Fund, with the only difference being it is being bought and sold as a stock. These are called Exchange Traded Funds (ETFs). The only ETF in the Philippines that follows the PSEi is First Metro Philippine Equity ETF (FMETF). It has the lowest management fee at 0.75%. You can buy this in any Philippine broker. If you are interested on investing in ETFs tracking the US Top 500 Index, here's how.

Advantages:

1. Lower fees - Nobody is manually picking any stocks or assets for you so that reduces operational overhead. (Why do management fees matter?)

2. Transparency - You know what companies are in the Index. If you buy FMETF, that means you have bought 30 companies that comprises the PSEi. Buying Vanguard Total Stock Market (VTI) means you bought 3,000+ companies in the US, including everything included in the S&P500. Talk about diversification!

3. You can track performance, easily - You can always check the value of indices every day, and you can safely assume that would also be the progress of your investment. You can track PSEi Index here.

4. It represents the market - PSEi represents the performance of the Philippine stock market in average. In the US, they have the S&P 500 which represents the US Stock Market performance. This is where people get the term "beating the market". When you are able to "beat" the market, that means you have outperformed a particular market index.

Disadvantages:

1. As mentioned above, indices represent the average of the market. So, that's all you'll get.

What are Actively Managed Funds?

These are mutual funds that are professionally managed by a fund manager. They do all the research on which stocks, securities and other financial assets to put the fund in. The common goal in mind is to "beat the market" which means outperforming a particular index. One good indicator on a performing Mutual Fund is comparing it to the market index. For US based funds, you can compare it with the performance of the S&P500. For Philippine mutual funds, you can compare it against the PSEi Index. The top 5 Equity Mutual funds in 2020 (reference from pesolab)

Advantages

1. Opportunity to beat the market - Some funds have posted huge returns, but you'll need to check the performance over the last 5-10 years for consistency. Another thing to note is that the fund's history does not hold any guarantees, and performance may change over time.

2. Lessen impact during market depression - Because these kinds of funds are professionally managed, they can make a plan to lessen the impact of market downtrends.

Disadvantages

1. Higher Management Fees and other charges - Because the fund is professionally managed, this results in additional operational overhead. Every time the fund manager buys and sells assets, it also incurs charges and taxes. This usually gets taken out of the fund performance itself. You get charged regardless of fund performance.

2. Hard to predict the performance - Unlike indices where you can get reports on a daily basis, it's hard to predict an actively managed fund because it will depend on the decisions of the fund manager/s.

3. There's evidence that most actively managed funds underperform the market. Statistics tell us that it's hard to beat the market over time.

As an investor, it depends on your strategy and weighing the pros and cons. You can get the best of both worlds, or stick to one type of fund. It's your money, take control of it.