How do mutual funds work? The fund I invested in is called an "equity fund". That means the fund invests primarily in Philippine stocks. If the stocks prices go up, so does the fund value. If the stocks prices go down, the fund value goes down. The fund value is expressed as the NAVPS or Net Asset Value Per Share. Simply put, when you invest, you buy shares in the mutual fund. The NAVPS tells you how much each share is worth.
For example: You invest P1000. If the NAVPS is P2.00 then the number of shares bought is P1000 divided by P2.00 per share, or 500 shares.
- If the NAVPS rises to P2.25 and you then sell your shares, you receive 500 shares multiplied by P2.25 per share, or P1125. You made a profit of P125 on your initial investment.
- If instead of rising the NAVPS falls to P1.75 and you sell your shares, you receive P875 or a P125 loss.
Sales loads are fees charged to investors when they invest (buy) or redeem (sell) shares. A front-end sales load is charged when you buy into the fund. A back-end load is charged when you redeem your money. Each time you invest you are given the option of which sales load applies.
A front-end load is typically lower than a back-end load. Some funds charge lower back-end loads depending on how long you keep your money invested.
For example: You make an initial investment of P10,000 in a mutual fund. You choose the front-end load option of 2%. The sales load is P10,000 x 2% = P200. The money invested is P9800. If the NAVPS is P2.00 then the number of shares bought is P9800 / P2.00 = 4900 shares.
A back-end load might be something like 5%, with a reduction of 1% for every year the money stays invested. For example after two years the back-end load would be 3%, after three or more additional years the load would be 0%. I'm not sure if all mutual fund companies offer such back-end load reductions. If so, it would be a good way to avoid sales loads if you're sure you're in it for the long-term.
So what about back-end loads? Let's say you have 3000 shares that you want to redeem. If the NAVPS is P2.00 then the shares are worth 3000 x P2.00 = P6,000. If the back-end load is 3% then P6000 x 3% = P180. That's the amount the company will charge, thus leaving you with P6000 - P180 = P5820.
Another thing to think about is risk. Mutual fund returns are typically higher than any savings product banks can offer. These higher returns come with risks. Mutual fund investments are NOT insured by the government. It is also possible for your investment to fall below its initial value. For example if you had invested in a mutual fund in 2007 and pulled out in 2008 you probably would have lost a significant amount of your initial investment. So why invest in mutual funds at all? Because historically they offer much higher returns than traditional bank deposits when invested for the long term. Caveat: Past results are not a guarantee of future performance.
In the next post I'll write more about mutual fund investments. If you have anything to say or ask please post a comment!