“Don’t save what is left after spending; spend what is left after saving” is a very popular quote from Warren Buffet which clearly reflects the importance of saving before spending. Hope everyone read our previous segment on finance “Why majority will never be rich” where it was clearly emphasized why saving is important.
So let’s get to the basics. Are you currently saving a portion of your monthly income? Or are you planning to start saving on a routine basis? What options do you have to save your monthly income?
Saving is actually a discipline which requires immense control especially in today’s context with new gadgets and so many new things popping up and trying to grab your attention.
Truthfully, I saw a budget smart watch couple of days back and it has been troubling me ever since to buy one. With these increasing needs, how do we save before spending?
There are myriad of ways in which we can save on a monthly basis. You can open another savings and transfer the savings, deposit in a fixed deposit, invest in the stock market or even alternative investments such as gold, property etc., which depends on your risk tolerance and investment horizon.
Let me tell you how I save on a monthly basis. Some of you might be familiar with this while for others it might be new. It’s called Unit Trust or Mutual Funds which are very simple in nature and not as complexed as investing directly in fixed income securities or the stock market.
What’s a Mutual Fund?
Mutual funds are a collective investment vehicle where the investors are small scale retail investors (people like myself) and institutional investors. Basically, what’s happening is that the firm which created the fund will collect the deposits from various investors and invest them in a wide spectrum of interest earning securities including fixed deposits, debentures, Government securities, commercial paper and even in listed stocks.
“Do not put all the eggs in one basket” – Warren Buffet
Moving on to how I save in mutual funds, the amount I wanted to save every month goes directly to my mutual fund account as the company pays my salary. If the HR department in your company is willing, you can make that arrangement too. The other option is to place a standing order with the bank to transfer a certain amount on a specific day to your mutual fund account (but that option will cost you additionally to facilitate the standing order through your bank.) If not, to make things simpler, you can withdraw your monthly saving and deposit in the designated bank account of your mutual fund (make sure you do this on the day you get the salary, or it will never happen!).
The unit trust industry (mutual fund industry) which is more than 20 years old in Sri Lanka with currently 16 companies managing more than 60 funds is regulated by the Securities and Exchange Commission of Sri Lanka. The industry is still growing and fairly large now which shows the confidence placed on them by the investors.
What’s the big deal?
There are couple of factors contrasting this from other instruments. It’s very flexible in terms of the amount you invest which is even as small as Rs.1, 000, which will not be the case if you are investing directly in, let’s say Government Treasury Bills which require a large investment. So it gives the opportunity to gain exposure to these investments, which otherwise is not accessible for small scale investors.
The fund manager diversifies the funds’ investments which reduces the risk without investing in a singles security. The benefit of diversification is provided to the unit holders who might not have the financial capacity or time to diversify the portfolio of investments. If you take a fund that invests in the stock market, they will invest in several shares and diversify the risk. Further, we don’t have to spend time analyzing the stock market or the fixed income securities which actually relives us of all that work to make our investment decisions.
In addition, compared to fixed deposits the mutual funds provide the convenience of withdrawing anytime, however certain funds impose an exit fee to compensate the early withdrawal of funds. This provides the option to withdraw in case of an emergency giving an edge over fixed deposits.
How does it work?
Before looking at how the buying and selling of units work, let’s look at the broad mutual fund types. There are two types of mutual funds, i.e. Open ended and Close ended.
Open ended mutual fund is where the fund managing company can issue new units based on the new deposits it receives, while in close ended funds the units in the fund is basically fixed which are upon redemption traded (for example like stocks in the stock market, if the fund is listed).
Unit Trust is not at all a complicated product; it’s very simple as buying and selling stocks. There is a buying price and selling price for the units which is based on the per unit value of the fund. Let’s assume you invest Rs10,000 today and the price of a unit in a particular fund in Rs100. Simply you will be buying 100 units to your account. If the price of the unit is Rs105 in a years’ time, you can sell the units back to the fund managing firm and get the proceeds of Rs10,500 transferred to your bank account.
Factors to look for.
- Historic performance
- Fees (Management fee, exit fee, trustee fees etc.)
- Funds objective
These are just few factors which I believe are important.
The final point which I want to emphasize is that, mutual funds invest in equity and fixed income securities which has its own risk and return, which means that the fund’s performance will fluctuate as the securities in the fund fluctuates. So we can’t expect a fixed return as a fixed deposit, but serves the purpose to foster the saving habit. So it’s paramount that you meticulously understand all the aspects of the product in which you invest that suits your preference.
Make sure you speak to the right professionals in the industry regarding the investment vehicle and understand the risk, return profile and invest wisely. Today is a great day to start saving! And don’t forget to continue saving!
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