'Can I lose everything I've invested in mutual funds?'

Received this by email from reader Benjo Arcinas: In addition to what Noet Ravalo explained so well, it is important to understand the universal relationship between risk and reward. The higher the risk, the higher the potential rewards, and potential losses. Many people are victimized by the promise of high rewards and no risk - - there is no such thing. And in turn risk can be reduced through diversification (i.e., "never put all your eggs in one basket") of investment portfolios (by the investor himself by spreading out his investments and by the fund manager by investing for example in instruments of different risk characteristics) and by pro-active
portfolio management by the fund manager whose function precisely it is to maximize returns and minimize losses for his many investors.

I found this Inquirer.net article quite concise and comprehensive, hope it's okay if I put it up here.

The tug of war between risks and rewards
INQUIRER.net, ,09:09am, 03/20/2007
http://business.inquirer.net/money/personalfinance/view_article.php?article_id=55855

Q: I find the interest earned by my dollar time deposit in the bank too small, roughly 3.5% per annum. During my last home leave, an investment adviser approached me about transferring my money to their Global Fund which will give a bigger interest, roughly 12 to 20%. Can you give me your advice on this? My savings are intended for my retirement and I plan to retire in 3 years. - Ed Tecson

Q: I work as a deckhand in a cruise ship based in Singapore. For the last two years, I have been able to place P220,000 in my savings account as I add P10,000 each month to this account. This is the only remaining cash I have after paying my bills and mortgage (P25,000/month). However, I find that the cash I’m saving does not grow the way I anticipated. Please advise if there is another way I can make my savings grow without the unnecessary apprehension from the volatility in the stock market. - Emerson Castro

A: Saving is a wise habit. It lays the groundwork for financial stability in the future. But saving alone cannot guarantee a rosy future, as both of you have seen.

The interest rate offered by traditional savings accounts is very minimal and may not be enough to offset the effect of inflation on your money. Time deposits have better interest rates, but still, the yield is not that high.

It is therefore not enough to just save. Good financial management calls for these savings to be invested well so a wealth of returns may be harvested.

The rewards of investing

Investing makes your money grow faster. According to “Financial Tips for Parents”, a brochure published by Citibank last year, if you had $10,000 and deposited it in a dollar time deposit in January 1988, after 16 years (December 2004), that amount would have grown to just over $20,000. But if this was invested in bonds, the amount at the end of the same term would be $36,000. If you went for stocks, it could have become $40,000.

Second, by investing in different kinds of investments (bonds, stocks, real estate), you curb the effects of inflation. Inflation is the general increase in prices. It affects the purchasing power of your money. According to The Citibank Guide to Building Personal Wealth, if your investment earns at a rate higher than the inflation rate, the value of your money is kept intact. Otherwise, your investment will not be worth as much in the future as at the time you first made the investment.

Third, when you invest, you will be able to achieve your financial goals at a shorter time. This is especially true if you hold your investments for the long term. Your capital will earn interest, and it will earn interest on top of previously earned interest — this is the principle of compounding.

The risks of investing

The bad news is you cannot just reap the rewards of investing without assuming some risk. Nothing is certain and no one can predict the future. “In general, the less risky an investment, the lower the return… Conversely, the more risky an investment, the higher the return may be,” states The Citibank Guide to Building Personal Wealth.

Below is a list of investment products and their corresponding risk:

Bank deposits least risky Highly rated bonds least risky Corporate bonds medium risk Real estate medium risk Equities medium risk Junk bonds very risky Your own business very risky Derivatives and commodities very risky

Your savings accounts and time deposits earn a low interest rate because they come with very little risk — you are guaranteed to get your capital back when you terminate the account, plus interest, unless the bank closes. In that case, the Philippine Deposit Insurance Corporation will give you back your money up to the amount of P250,000, the amount of coverage for every depositor.

If you want higher returns, be ready to assume a higher risk of losing your capital. Real estate, for one, is on the way up these days, and so, real estate bought five years ago may shoot up in market value today. But the real estate market is at times on the downtrend, as what happened in the late ‘90s during the Asian financial crisis. It is possible to have a market value lower than your previous purchase price for a property.

Prices of stocks or equities fluctuate wildly depending on the market. You will thus see your investment go up or down every single day. In the long run, though, historically, equities have performed better and given higher gains than other forms of investments.

Between the low-earning bank deposits and the volatile stock market, there are bonds. These are IOUs by companies or governments: they promise to pay the investor a certain interest rate periodically over a certain number of years. There is that risk too, of losing your investment if the bond issuer defaults on payments, but this does not happen often since bonds are given ratings by international rating agencies. Those with higher ratings carry less risk.

A mutual fund such as that offered to you may be invested by the fund manager solely in stocks, in bonds, or in a mix of investment classes. Given the diversified portfolio, there is a higher chance of achieving gains as one stock or bond may offset the losses of another. However, the rate of return is not guaranteed and short-term investors run the risk of losing part of the capital in the event they need to redeem during a market correction.

A unit investment trust fund (UITF) managed by a bank works the same way. What’s good about both the mutual fund and the UITF is that you can join the fund even if your money placement is small. The fund pools money from several small investors. Again, the rate of return is not guaranteed so look at the historical performance of the fund over a number of years. When the fund earns, though, it may give you a higher rate than that offered by bank deposits.

Your call

When choosing where to invest your money, ask yourself how much risk you can take. If you can take on a little more risk, then you open yourself up to a world of possible higher returns. That’s making your money work for you.

* just to clarify article above re: risks on investment products :) *

Below is a list of investment products and their corresponding risk:

- Bank deposits least risky
- Highly rated bonds least risky
- Corporate bonds medium risk
- Real estate medium risk
- Equities medium risk
- Junk bonds very risky
- Your own business very risky
- Derivatives and commodities very risky

government bonds and securities are considered virtually risk-free. they have higher rates than time deposit especially the long term bonds. i think the minimum is P100000.you can have it registered in your name or thru a sub-account of the bank or a custodian.

Hi hachiko,

risk is relative and how risky an investment is depends on the type of risk we are measuring

just some comments on the summary of instruments and their corresponding risk ;

what do you think is riskier? deposits with the rural bank of angora or corporate papers issued by ayala?(bank deposits least risky?)

is it riskier to buy one common share of san miguel corporation as compared to putting your money in a savings account? (equities medium risk?)

how about if i open a very popular fast food franchise in makati as compared to buying properties in timbuktu?(own business very risky?)

thanks

Yup, risk is relative, of course you have to screen out the underlying biz plan, security, guarantee, etc. Proper risk-reward information still underpins good investment decisions; i.e. example (3) in favor of fastfood.

For examples (1) and (2), time horizon matters; bank deposits won't be that risky if I could encash it this afternoon!

The article justifiably discussed risk naman in very general terms, though I'd slightly re-arrange their risk-return hierarchy as follows:

- Low risk: Bank deposits

* hmm, naputol :D *

- Low risk: Bank deposits, Highly rated bonds, Corporate bonds
- Medium risk: Real estate, Junk bonds, Commodities, diversified equity portfolio
- High risk: Individual equities, Your own business, Derivatives

hi jeff, don2x and hachiko, great discussion. Jeff has this powerpoint presentation on risks and returns that really wakes you up. hope you can share that one jeff :)

"Government bonds and securities are considered virtually risk-free", Don2x says. That is so...IF you are referring only to DEFAULT risk. People sometimes misunderstand that there is only one kind of risk. Gov't securities are in fact exposed to other risks like inflation rate risk and interest rate risk.

i meant government bonds for public offering which have best discount as compared to the yields as resold by the banks. i think best public offering of government bonds is still consistent with their inflation targeting. it would be safe to buy if discount offer is above current inflation holding it at maturity and re-invest periodic interest income. what is risky is trading of the bonds which has similar volatility as equities. pdex is a bond exchange market but is not yet open to the public.

the simple answer is YES.

depending on the fund and depending on the timing (think late tech stocks/fund investors caught chasing returns and pouring money at the peak of the bubble).

Technically, YES.

However, that depends on...
the asset class (or classes)
the fund manager (and his/her investment style)
the underlying assets (which issuers)
the outlook for the market (and the economy)
the risk tolerance of the investor
the time horizon of the investor
the investment experience of the investor
the financial objective of the investor

According to Dr. Jeremy Siegel of the Wharton Business School... stocks offered (and still do) the best risk-adjusted, after-inflation returns vs. any other asset class in the last 200 years.

This should continue since companies are in existence because of the primary reason of making profits.

And that will make shareholders happy (and rich).

I can understand how nervous you were after the guy you met was no ordinary guy but I have to say that the header had me scared for a sec I thought what I have in mutual fund was at risk or whether a recession was on the way. God! economic crisis, I just hope whatever we're investing whether in stocks , properties, accounts etc always remains safe so that we remain safe. The unpredictability of the market and this and that imbalances scares me but I'm glad some of my doubts cleared by going through the links you posted here. Thanks for all the help and all the valuable info.

Siena Las Vegas

This should continue since companies are in existence because of the primary reason of making profits.
And that will make shareholders happy (and rich).
Best regards, Alex, CEO of youtube to mp3

hird, when you invest, you will be able to achieve your financial goals at a shorter time.
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I'm sure many Filipinos will benefit reading your articles but I also hope that we can bring this down to a level where even our non-educated poor can benefit as well. I'm sure that with our great passion for Ginault Watches
, we can achieve this and lift many more lives out of poverty. Now for my question. I'm currently investing in mutual funds, but I would like to know how risky this can be? What are the chances of loosing everything that I have invested? What would it take for that to happen? -- Niño Allan E. Mulles