Mutual Funds: Know How Your Money Earns

If you are planning to invest in a mutual fund, it is a MUST that you understand how your money will earn.  Information pertaining to this can be looked up in the internet, but the investment jargon may complicate what should be a simple computation. Asking a licensed representative is the BEST OPTION since you can immediately throw in questions whose answers could shed light on your investment options.

This blog will simplify information on how a mutual fund investment earns. To understand it best, I came up with a scenario to see how an EQUITY MUTUAL FUND earns. Note that an equity mutual fund is just one type of a mutual fund. At the end of this blog, I will provide a simple explanation how this differs with the other types.

WARNING: This blog includes simple math calculations. Read at your own risk.

SCENARIO: You invested Php 10,000 last June 20, 2008 in an equity mutual fund. At the end of the business day, the NAVPS is at 1.6531. Your investment has a 5% back-end load.

JARGON SIMPLIFIED

• An equity mutual fund is primarily invested in stocks. The type of stock it is investment into depends on the investment objective. For illustration purposes, we will use the fund that mirrors the PSEi.
• NAV (Net Asset Value) is a fund’s assets minus liabilities. It is the value of the mutual fund (MF).
• NAVPS (NAV per share) is the value of one share in the MF. It is basically the price of one share, for both buying and selling. It fluctuates every business day depending on the market performance of the fund.
• Business day is the trading day.
• Back-end load is a type of sales-charge that is levied when investment is redeemed.

THE NUMBER OF SHARES

The number of shares (S) you bought for Php 10,000 last June 20, 2008 when NAVPS is at 1.6531 is obtained by simply dividing your initial investment with the price per share or NAVPS.

 Thus your Php 10,000 initial investment gives you 6,049.24 shares.

HOW DOES MY MONEY EARN?

Basically, if you are invested in an equity MF, it earns when the PSEi gains points. To know how much your investment has increased based on your initial investment, then you simply multiply the current NAVPS with the number of shares (S) you have.

Below is the historical index quotes for PSEi and NAVPS for a certain equity mutual fund. It shows that NAVPS increases as PSEi gains points.

 After two years, your 6,049.24 shares pegged at NAVPS of 2.0490 on June 23, 2010 has a total value of:

Thus, your initial investment of Php 10,000 is now (June 23, 2010) valued at Php 12,394.89.

The table below shows the value of your Php 10,000 last June 20, 2008, and each year thereafter until yesterday’s business day.

Note that after a year, when the PSEi loses points, the value of your investment went down to Php 9, 312.20. So, when you are invested in an equity mutual fund, you care a lot about the movement of the PSEi because that's where your fund is invested in. How it moves is NOT in your hands though.

CAN I REDEEM (or encash) THE TOTAL VALUE OF MY INVESTMENT?

Yes and No. Yes, you can redeem the total value of your investment after 5 years; No, if you withdraw in less than 5 years.

In our scenario, the investment is placed with a 5% back-end load. If you withdraw your investment within a year, 5% will be taken out from the total value of your investment. If within 2 years, 4%; within 3 years, 3%; within 2 years, 2%; within 4 years, 1%; and after 5 years, there is NO SALES CHARGE to be deducted from your investment. Hence, this investment works best if you have a long-term horizon. 

However, you have the option to have the sales charge deducted at the start. This is called front-end load. In such case, your Php 10,000 investment will be deducted first with the sales charge, then whatever amount is remaining will be used to buy shares at the current NAVPS. When you redeem your shares, there will be no deduction for sales charge as it has been taken out at the start of your investment.
Note however that VAT exists for both front-end and back-end loads.

The table below shows the 5% back-end load, and the money you can redeem after the sales charge is deducted. 

After almost five years, your money more than doubled, which will NEVER happen when it is invested in banks.

SO HOW DOES THIS DIFFER FROM OTHER TYPES OF MUTUAL FUNDS?

The equity mutual fund is suited for aggressive type of investors. This fund earns heavily and loses heavily. Other funds are computed in the same manner, but with smaller amounts of loss or gain. The bond fund is the most conservative, but the with the lowest level of risk, and the balanced fund comes in between.

DISCLAIMER

If you are interested to invest, it is BEST to contact a licensed representative. Information such as the rates and charges differ from one mutual fund to another.

Feel free to submit through the comments section any information I placed that needs correction, or any other useful information. This blog is meant for people who needs information, but is too shy to ask a representative, or to those who have invested without fully understanding how their money will earn.

PROSPECTUS

All information that you NEED to know about a mutual fund is contained in a prospectus. By SEC regulation, all prospective investors must be provided with a prospectus prior to investing. You may contact me if you want to be referred to a Philippine licensed representative.

To know the basics of mutual funds, read my blog Mutual Funds Basics.