A dummy’s guide to mark-to-market valuation

Finally, I found the most laymanized definition of this financial market term called “mark-to-market”. From Noet Ravalo’s article today, mark-to-market or M2M means:

If the market price of a traded security goes up today, a gain is duly recognized today. If today’s market price is lower than yesterday, the investor takes a loss today.

Why is it important to understand M2M? Because it can tip the scales in the way you look at your investments. Wiki’s simple example illustrates this point:

As an example, what if an investor owns 100 shares of a particular stock purchased originally for $40 per share, and that stock is currently trading at $60 per share, then the “mark to market” value of the investor’s shares is equal to (100 shares × $60), or $6000, whereas the Book value might (depending on the accounting principles used) only equal $4000. Similarly, if the stock falls to $30 dollars, the mark-to-market value is $3000, and the investor has lost $1000 of the original investment.

Here is Investopedia.com’s definition:

The act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value. In terms of mutual funds, a MTM is when the net asset value (NAV) of the fund is valued upon the most current market values.

Shifting to M2M proved to be a necessary pain for Philippine financial markets. If you remember what happened to the unit investment trust fund industry last year, it was required to shift to M2M from an accrual method of accounting where the returns they were presenting to investors were annualized and therefore much higher than they actually were.

The timing could not have been more awful. By May, interest rates fell and investors, who were not educated about the risks that come with the investment and were only chasing after returns, panicked. Massive withdrawals fed into the uncertainty and caused values to fall even more.

Those who bailed out at that time lost huge chunks of their savings. Had they kept their cool and focused on why they were investing in the first place, they would have recovered their losses a few months after the UITF scare.

Lesson learned: mark-to-market helps investors know where they are at any given day. It’s a big help because in the past, a lot of investments have been marked-to-models using various kinds of financial models, and, as Wiki says so eloquently, marked-to-fantasies resulting in investments that seemed to be more attractive than they actually were.

But Noet says the uses of M2M may sometimes be misunderstood.

An investor may get a 2-year bond and be contented with the bond’s promised coupons. In the absence of any intent to trade before maturity, there is no need to apply M2M valuation. Then there are assets that are declared to be available-for-sale (AFS). These can be held to maturity but can also be traded as opportunities arise. As such, M2M is applied but the daily gains or losses go to the balance sheet rather than the income statement.

To me, the greatest learning is to understand that “the best bet for choosing investments is still to match the risks of the products with your own risk tolerance.”

Read: stop chasing only after returns. As you well know, this is the kind of mentality that makes our kababayans vulnerable to the Multitels, the Francswiss and the Deutchfrancs of this world. Using the strategy of matching your risk preference with an investment instruments risk profile let’s your relax instead of always tracking how much you’re making.

Other wealth bloggers have their own take on the best way to get rich. OGC Wealth Trigonomics says people need a wealth accumulation program that really works and lists a very intriguing set of truths that a person must understand before he can actually make the leap.

Investing and the Filipino talks about how happy he is with his mutual fund investment (congratulations!), The Simple Pinoy Investor warns against getting stuck in a state of paralysis by analysis. Meaning you read and read and read about financial planning and never get to start investing! Good point, Pinoy Investor!

Speaking of analysis, here is something that I hope will not push you all to paralysis :). The Digerati Life has a really compelling entry on Why You Spend And Save The Way You Do: The Science Behind Money Behaviors. Are you a spendthrift, a frugalist or a tightwad? Carnegie Mellon and Stanford University apparently believes they are not all the same.

Follow the Process observes that the PSE has approved short-selling for big companies. Be careful there, dude. Short-selling is not for the faint-hearted! Good luck to you as well :). AllFinancialMatters asks whether it is silly to buy more stuff to get free shipping. All guilty persons, raise your hand…

I thought about breaking down Gloria’s promises on the economic front, but Manolo’s Post-SONA hangover 2007 edition will tell you all you need to know.

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