A Guide to Investing – Mutual Funds, UITF’s and Life Insurance

A Guide to Investing – Mutual Funds, UITF’s and Life Insurance



Looking back at the year thus far, we can see that the good times of 2009 and 2010 made way for a painful hangover in the first quarter of 2011. But, after a slow start to the year, the market has been spurred back to life by the PLDT acquisition of Digital Telecommunications and fund managers are beginning to wonder if it is time to get back in. Foreign funds that fled emerging markets when uprising in Egypt and Libya threatened to destabilize the continent are now starting to trickle back in. The world has seen the resilience of the Japanese in their ability to pick themselves up after the 9.0 earthquake and 8 meter high tsunami killed 13,858 people. Oil prices are starting to normalize. And locally, President Aquino has convinced us that his Public-Private Partnership (PPP) initiative will make our country competitive again, nurturing the growing belief that the index will hit a new all-time high this year. Though inflation and interest rates are the major concerns for this year, optimism remains high, and the market is poised for growth from now until the end of the year.


If you are a newcomer to the world of investments, you’ll probably be wondering how you can capitalize on this growth. Although it might seem intimidating, the good news is that you’re not short of options. As a new investor, recommended investments include mutual funds, UITF’s, and insurance products. But before trying to understand the different products, the first thing you need to understand is your risk profile.


Without going into too much detail, the basic concept of risk is that, generally speaking, the more risky an investment is the higher potential return it has. So before deciding where to invest, it is important to understand your risk profile. Typically, the younger you are, the higher your risk tolerance, simply because you would have more time to make up for any investment losses. Keep in mind, time is the greatest risk mitigator. For example, stocks are considered a risky investment, and from year to year, returns can vary from being positive or negative. This kind of volatility is what makes it a risky investment. However, if you annualize profits over time, you’ll see that your average income will beat the rate of inflation.


Ultimately, everyone’s risk profile is different and therefore, everyone has a different investment goal. But two investment vehicles which cater to a broad range of risk appetites are mutual funds and Unit Investment Trust Funds (UITF’s). Mutual funds and UITF’s are both open-ended pooled funds managed by an experienced fund manager. These funds pool money from investors and, under the direction of the fund manager, are invested in different asset classes, creating a diversified portfolio of investments.


However, there are fundamental differences between mutual funds and UITF’s which a potential investor needs to know. Mutual funds are like corporations where each investor is a shareholder of the company. As a shareholder, the investor has the power to nominate and elect a fund manager depending on the number of shares he owns. Moreover, shareholders receive dividends in the form of cash or additional shares.


On the other hand, UITF’s are simply funds handled by the trust department of the bank acting as the fund manager. Investors in UITF’s receive units rather than shares. They do not receive dividends but also do not get charged entry and/or exit fees, which investors in mutual funds get charged. Other key differences between the two include how they are regulated (mutual funds are regulated by the Securities and Exchange Commission while UITF’s are regulated by the Bangko Sentral ng Pilipinas), and what their maximum weighting in any one security can be (it’s 10% for mutual funds and 15% for UITF’s). Moreover, as a liquidity measure, mutual funds are required to hold 10% of its assets in cash or liquid securities (securities that can be readily sold at reasonable prices). These constraints limit the potential yield of mutual funds compared to UITF’s, but also make them slightly less risky.


Regardless of whether you decide to invest in a mutual fund or a UITF, it is more important to consider what type of fund you want to invest in. There are four main types to choose from – money market funds, bond funds, balanced funds, and equity funds. Money market funds are very conservative. They are invested in short-term fixed income government and corporate instruments, time deposits, and the like. The risks are very minimal but the potential yield is consequently quite low. Bond funds are also aimed at the risk-averse investor but allow investments in long-term fixed income instruments. This makes these funds slightly more risky than money market funds, but it allows them to achieve potentially higher returns.


The riskiest of the four fund types is the equity fund. It is targeted toward investors who seek long-term capital appreciation through investments in stocks. The potential yield from these funds is the highest, highlighted by the fact that the PSEi gained 63% in 2009. However, these funds have the biggest potential downside, highlighted by the fact the the PSEi lost 48% in 2008. To mitigate that risk, balanced funds were created to offer investors exposure to the stock market, while at the same time investing a portion of its funds in fixed income instruments. These funds are ideal for those investors whose goal is capital appreciation, but who are also willing to sacrifice some potential yield in return for some protection against capital loss.


Other than mutual funds and UITF’s, life insurance can also be a suitable investment. There are two basic policies of life insurance to choose from– protection (i.e. term insurance) and investment (i.e. whole life, universal life, variable life). Protection policies are designed to provide a benefit in the event of a specified event (i.e. death), while investment policies are designed to facilitate growth of capital. Before considering investing in a life insurance policy, there are important points to consider. First, policies with an investment component cost much more than those without in the short term, and it is therefore important to analyze the financial resources at your disposable. It is not a good idea to buy an investment policy if you can’t afford an adequate face value, as this would leave you underinsured. Second, if you choose a term policy, match the term to your needs – you want the policy to last as long as it takes your dependents to leave the nest, or for your retirement income to kick in. Third, buy when you are healthy and young as older people and those that are in poor health pay steeply higher rates.


Just as in mutual funds and UITF’s, insurance companies offer a wide range of plans catered to the different needs of the policyholder. The most basic type of coverage is term insurance, which has no investment component. You’re basically buying life coverage that lasts for a set period of time, provided you pay the monthly premium. Once the term of the policy ends, however, no benefits will be received unless the term is extended. Whole life policies combine life coverage with an investment fund. In this case, you’re buying a policy that pays a stated, fixed amount on your death, and part of your premium goes toward building a cash value from investments made by the insurance company. The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, and fixed and known annual premiums. However, the disadvantages are premium inflexibility and the internal rate of return of the policy may not be competitive with other investment alternatives. Universal life insurance is a relatively new product intended to provide insurance coverage with greater flexibility in premium payment and the potential for greater capital growth. These policies combine term insurance with a money market type of investment that pays a market rate of return. And finally, variable life and variable universal life are policies with an investment fund tied to a stock or bond mutual fund investment. This is the riskiest policy because returns cannot be guaranteed, but as you now know, with higher risk comes higher potential returns.


Although the array of possible investments can sometimes be mind-boggling, mutual funds, UITF’s and life insurance are a good entry point into investing for the new investor. As long as you set your investment goals, analyze the financial resources at your disposable, and evaluate your investment options thoroughly, you will be well-equipped to create a suitable and successful investment plan. And with the expected growth of the market this year, there is no better time to start than now.