Sunday, May 4, 2008

Mutual Funds 4 - Exit Points (Sell / Switch)

As in any investments, the approach should cover Exit Points - either to stop-loss, lock-in profits or rebalance asset allocation.

Given that a fund is performing badly (vs. investment in other funds during that period OR vs. other funds in the same sector) after 1 year-ish of holding, look into switching to a fund which I'd think would better performing for the coming year or two.

So far, I'm "lucky" enough to do this only once so far and it is due to "testing water" of a property focussed fund BEFORE the subprime issue.

Lock-in Profits:
Sell or switch when a investment transaction hits a profit target

When an asset type is more than X% (usually 5%) of planned allocation

Personal approach:
Personally, my long term expected average returns pa. from equity funds is 10% and bond funds 5%. Why these figures? Heheh - based on statistics of an index fund (10 years) which I have access to daily data since launched + others, the average pa. returns ranges from 8% pa to 12% pa.

Thus, my approach to locking-in is:
When fund profits hit abnormal returns pa. (in my case 16%+ pa for equity funds and 8%+ for bond funds)
AND cost + expected profits are >= $2,500 (to ensure that the switching cost is 1% or lower)
Switch cost + expected profits to a different country/sector or asset (equity to bond or vice-versa)
AND leave abnormal profits to run (heard of "cut losses short, let profits run" ? ;P)

If a particular transaction has already locked-in profits
AND hits abnormal returns pa.
AND the 50% of the profit run is >= $2,500
Switch 66.67% (2/3 lar) profits to a different country/sector or asset (equity to bond or vice-versa)
AND leave 33.33% (1/3 lar) profits to run (again I take profits and "cut losses short, let profits run" here)

Based on my own tracking PER BUY TRANSACTION and dividing reinvested dividends per buy transactions, most of my transactions' returns hitting above 16% pa will tend to drop after that. My Public Regional Sector and Prudential SmallCap hit >=20%+ pa returns and pulled back within 3 to 4 months after that. Thus, my personal approach helps me:
- take expected profits and cost back
- while leaving enough to "let the profits run" (in my case, abnormal profits)
- control downturns due to crazy exhuberant market getting logical (called a "market correction)
- rebalancing

I switch rather than sell back to the Funds House / redeem because I do not need the $ to live on, thus, I'd rather reinvest at NAV. FYI - selling/redeeming for cash AND buying back in incurs commission charges).

Friday, April 18, 2008

Mutual Funds 3 - Entry Point & Buy Criterias (examples)

With the above options, I usually go for lump sum (if small amount say $10K or via EPF) or a combination of Dollar Cost Averaging + Value Cost Averaging (Combo). No timing of market

If I get a windfall of say $50K or more, I'd rather break it into monthly investments using Combo approach.
Reason: I do not want to be unlucky and buy totally in, then having the whole market crash on me. By breaking up the lump sum of, say $150K, and doing monthly Combo approach within 2 to 3 years, I ensure probability is on my side that I won't be too unlucky.

Most of us have heard SALES agents say out Dollar Cost Averaging (DCA) whenever they can't get their paws on our lump $um. DCA is espoused by many to be a better way than lump sum - I agree. However, there's a better way than DCA - called Value Cost Averaging (VCA). The table above shows the concept of a controlled VCA - controlled by limited monthly resources available for investment - $1,000.

There's an even better approach - a combination of DCA + VCA. I got the idea from a book by Mr. Lichello, called TwinVest and reduced it into a spreadsheet. Just input the monthly amount you can put aside for this particular investment and every month / quarter /period, enter the sales price or NAV price (must be consistent). The spreadsheet will advise how much value to purchase.

All these - DCA vs. VCA vs. TwinVest has been randomly tested against each other and also backtested with Public Index Fund's data.

90%+ of the tests, using randomly generated prices and fixed amount available per month, shows that TwinVest gets more profits or lose less than DCA or VCA.
6%+ of the tests showed VCA beating TwinVest and DCA.
Never once did DCA beat VCA or TwinVest
The randomly generated test was simulated for a period of 10 years, investing every month.

Why aren't these SALES agents advising you to use TwinVest or even VCA? Simple - it takes slightly more effort on their part to calculate OR they don't even know of these two approaches. Most would rather get all your $ (lump sum) so that they don't "lose" you to another agent (meaning losing their commission opportunity) OR put you in auto-mode of DCA via standing instructions from a bank to pay to the Fund House.

Now you know more than most SALES agents - use the knowledge well ;P.

For SALES agents reading this - add value for your prospects and customers, they WILL stay with you and appreciate your efforts. Track and give them reports "per transaction" invested with returns/loss per annum, not simple GROSS returns and AVERAGE yearly returns - give compounded per annum returns - make it simple for your customers to compare against other investments. We know not all investments make $ and that even for those that make good $ there will be ups & downs - be transparent about performance ya ;P

Thursday, April 17, 2008

Mutual Funds 2 - Funds Selection (examples)

For every type of investment, there should be:
- Selection
- Approach / Management (some call it Entry & Exit plans)
It's the same with mutual funds.

Selection Methods
There are basically 2 approaches to selection that I've encountered with many minor variations:

1. Performance only
The above example is for this selection method. How to execute? Simple

a. Get Lipper's, MorningStar's and Normandy's ratings from The Edge (weekly), Personal Money (monthly) or websites

b. Filter off for your requirements
eg. I only accept ratings
Total Returns & Consistent Returns of 5/Leader
Preservation of >= 3
AND Morningstar rating of >= 4
AND Normandy's Sharpe Ratio >= 0.75 if possible, else the top quartile
(Sharpe or Information Ratio shows the amount of returns over the amount of risks - a higher number is better)

c. For those who have more time to kill, check each filtered fund's returns for 3, 1 & 5 years (please tweak these to your needs).
eg I'd weight 3 year's returns highest (3), 1 year's returns next (1.6) & 5 years returns last (1.5)
Why those years?
3 yrs - my expected minimum time horizon
1 yr - to keep my selection skewed to the more current performance
5 yrs - in anticipation that I'll be keeping my investment invested 5 years and more
If it's via EPF investment, I'll of course filter for EPF approved mutual funds.

2. Funds strategy in-line with Investor's strategy / risk appetite
a. If I'm an aggressive long-term investor, I'd filter out a fund house's "aggressive" or equity heavy and/or theme-based (eg sector rotation) funds.

b. Then, I'll review it's prospectus on how the funds will be invested and the fund's strategy

c. If I think it's in-line with my expectations, then I'll compare it with the rest of the funds which made the cut and make a decision

You may want to filter for fund houses first before the above. Personally, I'd only invest in funds from Fund Houses that:
- have enough variety of equity & bond funds (I hardly touch capital protected or balanced funds)
- who's funds are mostly performing above average against peers & benchmark for a 3 years period

Reasons: I usually switch from one asset class to another upon a returns per annum trigger. Switching can only be done between funds from the same Fund House.
Switching is a method to "sell" a fund & "buy" another without incurring commission / frontload costs of 3% to 8%.

Ok ok - those who are too blur or time-tied (ahem ahem) to research, I'm holding Prudential and Public Mutual funds. I've been with SBB (now called CIMB), Pacific Mutuals & BHLB - my experiences with these fund houses' funds weren't too great on average.

For those who are interested in capital protected funds - my opinion is that ING's are one of the better ones available.

Mutual Funds 1 - Before we begin

Ok here we go - $ make $.

Keep in mind, any $ put into any investments should be treated as "gone" / "untouchable" for at least 3 years. This doesn't mean that you can't sell down and reallocate to another asset / investment, ya ;P

I'll start off with mutual funds as most people think of stock investments as "high risk". By the time we're done, I hope you'll think of risk as managed risk, not just plain vanilla "high risk" "low risk". Just an aside - is driving "high risk"? Yes it is - if a blind untrained monkey is driving! If Michael whatshisname is driving, can you consider it low / managed risk? It all depends on the experience, knowledge and skills ya.

Mutual funds - what are they?
"Mutual", a simple view
- you, me + some others (well, a lot of others) collectively put our investment $ together, appoint a manager or managers to buy/sell stocks, bonds, money market, derivitives on our behalf. The manager(s) have to follow certain guidelines and will be audited/checked on by a third party.

A mutual fund has 3 parties involved:
- Investors (you, me + others invested in the fund)
- The Fund Management Company that buys/sells / asset allocate stocks, bonds, money market, derivitives for Investors
- The Trustee that checks and audits the Fund Management to ensure they comply with the Fund's directives / policies (each fund have their own policies /directives as part of their investment strategies)

Strengths of Mutual Funds:
+ Easy Diversification
+ IF Balance Fund (a fund that allocates 60% into Equities, 40% into Fixed Income instruments) used, do not need to actively asset re-allocate
+ Available asset classes are Equities & Bonds
+ Auto-cruise, plonk $ in and forget

Weaknesses of Mutual Funds:
- Relatively high cost of investment if cash is used for equity funds. Ranges between 5% to 8%! This means every $1 I put in, I get only $0.92 to $0.95 value at the start compared to stocks bought at EOQ (Economic Order Quantity - where the amount hits a low based on the brokerage cost) which is approximately 0.6% one way, thus two ways (buy/sell) approximately 1.2%+
- No direct control over what is invested in

I personally leverage mostly on my EPF a/c1 to invest in mutual funds as the charges are only 3% and since I can't touch my EPF $ until 55, leveraging on mutual funds is a near sure bet to beat EPF's 4.9% average returns pa. (since 2000 to 2007) .

Cash-wise, I use a Dollar Cost Averaging + Value Cost Averaging approach and only invest in foreign focussed mutual funds as EPF currently (mid 2007 onwards)disallow investments into foreign related mutual funds.

In whatever investments, huge lump sum investments should not be done. eg. if I inherited $200,000, I'll aim to invest the whole sum within 2 to 3 years, each month a specific amount put aside and invested using Dollar Cost Averaging + Value Averaging for Mutual Funds and Fundamental + Technical approach with Cash & Risk Management for Stocks.

Why 2 to 3 years? That's how long (statistically) a country falls and crawls out (Break Even, ie. no win, no lose) of a recession/depression. Longest I read was about 3 years in USA.

My investment approach is statistical and probability based. Like casinos - the long run game will get you $ even if the probability of winning is only 55% or 60%. Long run! That's why casinos make the $ and gamblers often lose in the long run.

Asset Allocation & Diversification within Assets - example using Retirement Plan

Here we are again, at the example of my retirement plan. As stated in an earlier post, this thing consist of 3 Parts.

Part 1 - The amount required per year during retirement to cover expenses
1. Take your current expenses / expected retirement expenses in current value of $ and calculate the pre-tax amount of $ needed.
Pre-tax amount of $ = the amount of gross salary / profits needed before the government gets their cut

2. Take the pre-tax amount of $ needed and calculate the future value of pre-tax amount of $ needed.
"Future value" = factoring in inflation, ie. $1 today can buy much more than $1 in 20 years time.

Part 2 - The asset allocation of my investments DURING retirement to generate Part 1 AND the total amount of $ needed for retirement investment
This is where I allocate my investment $ into asset classes which I'm familiar with and their respective average returns per annum.

Part 3 - The asset allocation of my investments to GENERATE Part 2's total amount of $ needed for retirement investment.
As per part 2 - asset allocation. Please note that this Excel sheet leverages on another sheet that extrapolates my EPF + EPF invested in Mutual Funds returns.

Diversification - reduce risk of having all eggs in a basket

As per the last posting, please remember - Asset Allocation isn't the same as Diversification. Both serves differing needs and are executed differently but complimentary to each other.

Above are examples of Diversification within an Asset Class or Asset Sub-Class.

Asset Allocation - to optimize returns, use the right combination of vehicles

Asset allocation - another funky sounding thinggy. No worries - it's just another term for "investing in different TYPES of stuff" heheh.

Simple example of 2 types or asset classes - equities and bonds / fixed income.
-Equities: You own a part of the item (company, property, etc.) and profit from it's business growth, dividends or bonus pay-out, etc., with no guarantees of any. Aggressive approach
-Bonds / Fixed Income: You lend your $ (investment) to someone (company, government, municipal, etc.) getting a fixed % of returns. Conservative approach

Why would I bother with these two examples instead of plonking all my investment $ in one of them? Simple! I want the best of both worlds

- Equities' average returns (long term) usually beats inflation
BUT there can be years of losses (negative returns) due to economic downturns
- Fixed Income's average returns (long term) usually follows or barely follows inflation (ie. I actually lose purchasing power, not gain)
BUT there can be years where bond returns are higher than Equities' returns.

Take a look at the "Worse Case Scenerio" where if I bought and held Equities on a high of 1997, then the Asian Currency Crisis came and whacked KLCI down to 200+ points, until 10th Mar 2008 post election political sell-off. Who says bonds' returns are ALWAYS lower than equities' returns? ;P

By allocation a % to each of these asset types which are NOT highly positively correlated (ie. if one falls, the other doesn't fall as much or may even be going up), I get an optimized return of minimums with no limits of maximums.

Anyone here heard of "diversification"? What's the difference between "asset allocation" vs. "diversification"?
- Asset allocation: to optimize returns
- Diversification: to reduce risk by spreading your investments within each asset type and subclasses
eg. Equities - spread between Stocks & Properties. In addition, in Stocks, I spread into Financial, Plantation, Manufacturing & Consumer Goods sectors.

Goals – How Much, By When, For What 2

The above is a sample of a retirement plan. There are 3 parts to it, for now ignore the last 2 parts:

Part 1 - The amount required per year during retirement to cover expenses
1. Take your current expenses / expected retirement expenses in current value of $ and calculate the pre-tax amount of $ needed.
Pre-tax amount of $ = the amount of gross salary / profits needed before the government gets their cut

2. Take the pre-tax amount of $ needed and calculate the future value of pre-tax amount of $ needed.
"Future value" = factoring in inflation, ie. $1 today can buy much more than $1 in 20 years time.

At the end of Part 1, you'll have the amount needed per year to be covered with your investments' returns during retirement. Scary numbers huh, especially if you're a pessimist / cautiously optimistic person like me - I assume average inflation per year to be 6% because of my lifestyle that uses non-controlled items :(

Please note that I'm planning to leave behind a sum for my child and hopefully, grand-child(ren), to kick-start their own investment plans. Thus, my retirement plan assumes that I live on my investment returns only, even having enough savings to re-invest a %. Due to this, I need a lump sum of $ to generate that amount of investment returns. If I don't intend to leave anything behind, the lump sum amount I'd need would be much less (approximately 80% to 90% less).

Goals – How Much, By When, For What 1

Foot note:
I'm assuming most of us are worker ants like me, thus, we've got EPF. However, if you're a business owner or sales focussed person and have low or no EPF, bonds and bond funds should be part of your investments.

Coverage - Child Education

Generally, I don't touch "child education insurances" except for it's tax relief purposes as the returns are usually miserable. Since I've 18 years to invest and make sufficient returns, investing into good companies' stocks, ETFs, REITs or mutual funds will handily beat the average returns from most "child education insurances".

Please note that Malaysia's income tax currently has 2 different reliefs pertaining to this area:

- child education insurance / medical insurance premiums: Up to RM3,000 pa

- SSPN from PTPTN: Up to RM3,000 pa

Coverage - Critical Illness Insurance

Foot note:
I personally have an approach where I buy 2 different insurances
- death / disability (2X paid out if accidental): for my family to continue on
- critical illness: to save my life, failing which, my family has the other insurance above (death / disability) to generate income for living expenses

Coverage - Disability Insurance

Coverage - Death Insurance 2

Foot note:
The example above is a personal experience of mine with a "famous" American insurance company.

I've also experienced a similar thing with a very prudent insurance company as well - where the first few years' "investment" portion of my insurance "bought" me 40% to a RM1 value! Hm.. didn't notice they whacked me 60% cost per year, declining every year until the 7th or 8th year where my RM1 will buy me RM1 worth of investment (NAV).

Coverage - Death Insurance 1

Death insurance or optimistically called Life insurance, should only be used if there are other people economically reliant on you for a living AND should be used only until you're retired.

If I'm not earning an income (but investing and making returns) during my retirement, why would I want to insure my death/life? I can cover my family with my Will and teaching them what to do with the lump sum of $ - like what I'm sharing now with you, ya.

Coverage - Overview

The slide above covers areas to cover. The main note is - get insurance for coverage (if and when sh*t hits the fan), not investment or forced savings. More on this in the next 2 posting.

Build a Buffer Zone - Staggered / Laddered Maturity Fixed Deposits

The main point here is to lower the chances of needing to cash in an FD's certificate before maturity and losing the interest returns due.

Build a Buffer Zone - minimum 3 to 6 moths' expenses, not salary

Other than the notes above, for those who are planning to "crashproof" their cash flow, you may want to have 1 year's living expenses in your buffer zone. Mind you, you most probably want to allocate your liquidity like something below to fight off inflation:
-2 to 3 months in bank account (lowest returns)
-3 to 4 months staggered / laddered in FDs (near / at inflation rate)
-6 months in bond funds / prepaid into flexi mortgage account (at / slightly higher than inflation rate)

The most important item to note is that without a buffer built, any cash investments you build will be extremely shaky as you may need to liquidate them at the wrong time.

Cash put into investments should be treated as unavailable for at least 3-5 years - having that mindset gives your investment time to grow above the costs you paid for them.

Expense - Know & Control - It's not how much you make, it's how much you keep

Remember the greates secret to amassing enough $? Yes? No? Well, it's such a stupendous secret that it's worth typing out again here ;P

The greatest secret to amassing enough $ is:
1. Spend less than you make
2. Put your savings into a buffer emergency fund + investments
3. Repeat step 1

A real-no brainer right? Well, most people, even myself in my younger and dumber daze (still dumb but not dumber ;P) keep aiming to make more $, yet keep forgetting the basics -

IF Expenses >= Income
...THEN Kaput / Digging a deeper hole

Everyone (and their dog) wants your $ - take a look at the ads everywhere enticing you - "you deserve it" yeah by paying through your nose or spending $ which you don't have (it's called credit).

Thus, as the pix states - know your expenses & control them. How?

1. List down, as much as possible, your yearly expenses by month and category.
This well help you estimate your monthly average expenses & surplus / deficit vs. your income.
For those who are hardworking, you can do is a monthly Cash Flow for the year.

2. Once the above is done, track your actual monthly expenses for at least 6 months and compare your actuals to your estimates.

By virtue of tracking your expenses, you'll be making a concious effort when spending money - "is it worth it?" will zip into your mind automatically sooner or later ;P

This step is critical - without knowing what's your expenses, you'll not be able to estimate how much you need for the all the following areas, even investments.

Step by Step - 1st things 1st

See the above? That's it - nothing else. Those are the basic checkpoints - all you have to do is to make them yours by taking responsibility and stepping up to take charge of your own financial wellbeing. No one can help you there unless you WANT TO BE there yar.

Let that sink in first.... until I delve into the most important step.

Introductions and The Big Picture

As I'm a virgin blogger, I think I'll start it off with something close to my heart - and based on my friends' questions, close to most of the average Joes & Janes heart or head sooner or later - WEALTH.

Wealth to me means enough $, great relationships & health. Hm.. out of the 3 components, as I'm EQ challenged (ask my HR people, they'll agree readibly + add salt too ;P), I'll share with you my own journey / experiences on the other two - $ & health here in this blog.

Let's kick it off with $ - everyone wants some, more, yours, mine, etc. At the heart of having $ is Financial Planning - big 2 words, actually quite easy if taken in bite sized steps. The greatest secret to amassing enough $ is:

1. Spend less than you make
2. Put your savings into a buffer emergency fund + investments
3. Repeat step 1


With that big secret out of the way, let's focus more on the nitty gritty. I'm from Malaysia (big secret with such a blog title huh), thus most of the stuff here will be related to good ol' Malaysia, where changes are afoot and people knows their votes can make a difference (for better or worse).

Ok ok - on with it. Below is an example of a "big picture" / overview of a plan. I'll share with you my ideas / experience at each each basic area, from the base upwards. Without a strong base, things topple easily, yar.