by By Efren LL. Cruz, RFP®
Europe is still deep in a debt crisis. Although the US may be coming out of its own financial crisis, economic growth is still expected to be tepid. The engines of growth in Asia, namely China and India, are battling high inflation and are also poised to slow down. The Philippines is by no means immune to the global growth slowdown. So where and in what is the best place to invest?
Every new year, newspapers, magazines, tv and radio talk shows and even blogs talk about the best places to invest. I prefer to shy away from making such recommendations especially during these volatile times when a particular investment outlet may be rendered unattractive a few weeks or months later. And when this change in fortune happens, I feel obligated to update readers on the new developments, something that may not be feasible especially when I am not invited by the media to do so by that time.
So rather than talk about particular investments that will be attractive for 2012, I’ll focus on the framework for choosing winning investments. This framework will have a better chance of standing the test of time.
The 5 Basic Steps
Just like with doing a business plan, investing must follow the six steps outlined below:
- Determine return objectives
- Assess risk tolerance
- Review available investment outlets
- Form optimally diversified portfolios
- Monitor investment performance
Many times, people come up to me to ask about where they can already put their (hard-earned) money. And invariably, I tell them that if they haven’t determined their return objectives and assessed their risk tolerance, they are setting themselves up for a dangerous investing voyage. They are like a ship without a rudder.
In fact, financial institutions and central banks have realized the folly of many investors of plunking their money in instruments that were not aligned with their return and risk preferences. That is why globally, investors are now being asked to fill up a suitability assessment that is designed to protect them. If the suitability assessment reveals that an investor is highly risk averse, then the financial institution should not peddle any high risk investment to him.
By already asking for the vehicles to invest in, people tend to forget the first two important steps to investing. And because they are focused on particular investments and not a diversified portfolio, they also tend to forget step 4.
Investing is not all about return. It is also about managing the risks. And one of the best ways to manage investment risk is to diversify or hold on to several positions whose individual risk characteristics tend to offset each other’s. Put another way, the poor performance of certain investments can be offset by the stellar performance of the others, giving the portfolio a still decent return. However, be wary of too much diversification as gains in some, even though they may be great, will hardly be felt for the entire portfolio.
The Set Rule
The 5 basic steps in investing actually pertain to investing directly, whether it is in financial securities or investing in a business. At our company, the Personal Finance Advisers Philippines Corporation or PFA, we developed a simple framework for determining whether a person should invest directly or not.
SET is an acronym for size of funds, expertise in investing and time to manage investments. Investing directly requires sizeable funds. Sure a person may be able to open an online stock brokerage account for only php25,000. However, those funds will not afford extraordinary care from the stock broker in terms of feeds of breaking corporate and economic news, and expected flow of funds in the stock market. Moreover, any news or analysis will only come from one stock broker and will not be balanced or validated by another.
When it comes to a business, working capital needs alone will require sizeable funds, not to mention funds needed for capital expenditures. The typical single proprietor also tends to forget that he has to provide for the working capital needs of his own household on top of those of his business. Funds will be needed to send the children to school, put food on the table, pay utilities and many more. Setting aside capital for the business alone will lead to early withdrawals to fund household needs and eventually a business lacking in capital.
Investing requires expertise. For any business to flourish there must be expertise in the four basic functions, namely: production, marketing, finance and human resources. If there is anything I have learned from running many businesses before it is that no one can be a jack of all trades. Investing in a business requires teamwork with the team members having their own line of specialization.
The same goes for investing directly in financial securities. If the trial courts say that hearsay is not admissible in court so too does direct investing in financial securities. Simply reading investing articles in newspapers and even on the web gives you yesterday’s news. Having the expertise to analyze, connect and/or extrapolate from the news is necessary. And this requires expertise that is honed over many years. Malcolm Gladwell in his book entitled “Outliers” said that for one to be an expert, he must have been practicing his skill for around 10,000 hours. And these 10,000 hours are roughly equivalent to 10 years. Popular examples of people who have gone through 10,000 hours of practice in their craft are Bill Gates and the late Steve Jobs. In investing, there are Warren Buffet, George Soros, Bill Gross and Larry Fink to name a few. The Philippines also has a long list of fund management experts. But I dare not name them as I may come out endorsing the funds they manage, something that we do not do at PFA. In addition, many of the fund managers are my friends, I being a former fund manager. And I run the risk of ruining a good friendship if I fail to name any.
Time to manage a business is very important. An absentee business owner will eventually be faced with absentee profits. I know of a business owner who found out that her employee was stealing money from the cash register. Even after installing a CCTV system, the employee creatively found a way to avoid the camera and still steal from the cash register. All this because the business owner was usually not at the business and the employee was left to mind the store alone. Given the higher volatility in investing in today’s financial securities, focus is a must. Through a review of historical returns of the PSEI as a portfolio vs. the returns of actively managed funds (using equity mutual funds as a proxy), I found out that at least in the Philippines, actively managed funds tend to outperform passively managed ones on a 1-, 3- and 5-year period ending in 2010 on simple average, compounded average and Peso Cost Averaging bases. And at the risk of stating the obvious, investing actively requires close attention.
Employees are very poor in focusing on a business or investments on top of their jobs. This is not to say that employees have no skill in focusing. They are just too busy with their current job to focus on another venture.
So is the employee or anybody else lacking in any one of the SET rules doomed to earning just from his salary or wage? The answer is of course no. A person can still invest in a business or financial securities provided he does so INDIRECTLY.
In fact, the broader rule is that if a person cannot comply even with just one of the SET rules, he should invest indirectly.
When it comes to the lack of sizeable funds, investing indirectly in a business requires that a person joins forces with others to raise capital and form a business. Investing indirectly in financial securities would mean investing through pooled funds like mutual funds, unit investment trust funds (UITFs), variable unit-linked insurance, real estate investment trusts and pre-need plans. The minimum investment size for mutual funds by law is Php5,000 for private sector employees and just Php1,000 for government employees. For some UITFs, the minimum is also just Php1,000.
When it comes to lack of expertise, investing indirectly in a business requires a person to hire a business manager who shares his passion for the business. The business manager will run the business as the Chief Operating Officer and in turn hire an excellent team to support him in running the four basic functions of a business. The person will be the capitalist and perhaps Chairman and Chief Executive Officer. If the person is currently an employee, he can take a less active role and confine himself to just being a shareholder. Once he retires from his employment, he can then take over the reins of a company made sustainable by expert hands. Again, when it comes to investing indirectly in financial securities, a person can buy into pooled funds that have seasoned investment professionals on board to manage funds 24/7. These professionals do nothing else but watch the markets, analyze reports, attend economic and company briefings, review and update themselves with investing laws and regulations, do company visits, perfect portfolio simulations and apply portfolio diagnostics to ensure flawless execution of strategies.
When it comes to the lack of time to manage investments, hiring a business manager solves it for investing indirectly in a business. For investing indirectly in financial securities, hiring a fund manager through a pooled fund or funds addresses the problem. Whether it is a business manager or a fund manager, these professionals have all the time in the world to manage investments because that is their precise occupation.
So before you invest, ask yourself first if you are all SET.
The Only Exception
Rules do have their exceptions. Our rule of not recommending particular investments has only one exception. The exception is our recommendation to invest in yourself. A leading Thai tech-entrepreneur and a business partner once said to my children that the shortest route to success is through reading. Dado Banatao, a Filipino who made it big in the technology industry in the US said in one of his TV interviews that education is the great equalizer. Warren Buffet, the world’s greatest investor says that he turns off the stock market when he invests. Why? Because he only invests in companies that profit regardless of the economy. And to do so would require him to pore over voluminous research materials.
To the three gentlemen just mentioned, knowledge is power. Knowledge is also available to anybody who wants it. All that is needed is to invest time and perhaps some money to acquire, practice and master it.
But investing in one’s self does not only pertain to acquiring knowledge. Investing in one’s self involves a holistic approach to being the best that one can be. Invariably, this involves investing in one’s health as well. Abusing the body may get you somewhere. But it will be literally short-lived. You don’t have to load up vitamins and minerals or follow the latest breakthrough diet.
For example, when your body is aching and tired, that is its way of telling you that you already need to rest. An episode on Discovery channel showed how sleep was important not just for resting but also for mastering newly acquired skills. A soccer player practicing his kicks during the day would likely dream of them at night as the brain masters the foot’s position and power with every desired kick output.
So many books and trainers talk about work-life balance. To my mind, a perfect example of this is the experience of a friend and schoolmate. My friend was at the top of our class and a career-oriented person. Brilliant as she may have been in her work, she opted to quit even when she will still far from peaking in her career. What made her quit was a simple but meaningful drawing of her child. Her child was asked to draw a picture of my friend’s family. As the story goes, the child drew the picture of the family including the nanny but without my friend in it. That simple picture hit home and hit hard. Today, my friend is enjoying her life with her family immensely and would probably not trade it for any high-flying career.
Not all have the luxury to have one breadwinner and one home maker in the family. Many households nowadays have both parents having to work. Nonetheless, work is work and family is family. When the time to call it a day comes, then call it a day. The family is now eagerly awaiting your return.
So if anyone was to ask me where the best place to invest in 2012 is, I would answer invest in yourself. In fact, every single year is a good time to invest in yourself.
There is so much more to discuss about investing. If you want to know more about investing in particular and the big picture of personal finance, attend one of our EnRich personal finance training programs. You may visit our web site at www. personalfinance.ph. Our company web site has a unique feature called “Ask a friend, Ask Efren”. You may submit any personal finance question and we guarantee a reply to you within the next 24 hours. Best of all, the service is FREE. This is our way of helping the Global Pinoy in personal finance.
You may also contact us via email at info@personalfinance. ph, call (63-2) 216-1541, YM/Skype Efren7962 or SMS/call (63917) 505-0709. You may also visit our free discussion forum called Income-Tacts at www. personalfinance.ph. Our Facebook page is Personal Finance Advisers Philippines Corporation.
Kung Hei Fat Choi and Kiong Hee Huat Tsai!
Efren LL. Cruz is a registered financial planner with RFP Philippines and a seasoned investment adviser. He is also the author of the bestselling books, “Pwede Na! The Complete Pinoy Guide to Personal Finance” and “Pwede Na! The Complete Pinoy Guide to Retirement & Estate Planning.” He is Chairman and CEO of Personal Finance Advisers Philippines Corporation. Questions about the article may be emailed to email@example.com. Efren may be reached at the same email address for the scheduling of consultations and personal finance trainings at (+632-216-1541 / +63917-505-0709). The opinion and views expressed herein are solely those of the author’s and do not necessarily reflect those of the Personal Finance Advisers Philippines Corporation.