Everyone needs a nest egg for a rainy day or the occasional splurge, but a little personal finance knowledge can make your savings grow so much faster. If you’re buying jewellery, putting money into a committee or even buying dollars to save, like many women, you’re not making your savings work hard enough. There’s no need to leave financial decisions to your menfolk. Whether you use conventional financial products or Islamic ones, some smart investing can help your own savings grow every year.
Why are financial instruments better than gold, dollars or kitty parties?
Financial instruments like term deposits, bonds, shares and mutual funds aim to grow your money. Don’t get scared off by the complex names – none of it too difficult to understand. They are well regulated and you can invest according to your own risk tolerance.
Gold may appreciate in the long term but you must factor in the making and the wastage and whatever else the jeweler cuts when you actually sell jewellery (around 12% total at least). Compare that to the growth from financial instruments and gold doesn’t glitter quite as much any more. Even if you are buying for a daughter’s wedding, bear in mind that tastes change and you would have been better off investing the money.
Dollars meanwhile, apart from being an interest-free loan to the United States, only make sense when there’s extreme uncertainty. Look at this graph of the rupee vs the dollar. From 2002 to 2008, the dollar rate barely changed while if your money had been on term deposit in a bank it would have grown around 58% over the 6 years (assuming a average 8% of interest).
As for ‘committees’, well kitty parties may be fun but, considering that you only get out the same amount you put in, they are more a way of socialising than investing. If you’re one of the first to get the pot, your friends are in effect giving you an interest-free loan but there’s really no financial sense to a committee apart from getting you to set aside that certain amount every month.
Finally neither gold nor dollars nor committees will give you any cashflows. You will get a lump sum when you sell dollars/gold or when you get the kitty but financial instruments can give you a regular cashflow with dividends, profit or interest.
So what is the best way to save?
Step 1 has to be working out what you can reasonably save every month. Try and get into the habit of setting aside some income every month to save. Next think about how can you make your savings work for you!There are several options. You can choose a term deposit with a bank – either conventional or Islamic. These pay you a fixed income on your money after the term chosen – with can be as little as 3 months and as long as 5 years. The money can be paid on a monthly or yearly basis. You can also choose to invest in the stock market, which has much higher rates of return, but investing in individual stocks is not really something anyone other than a financial analyst should do. That’s where mutual funds come in.
What is a mutual fund?
A mutual fund pools all their clients money and uses it to buy government securities, term deposits with banks, bonds or equities (shares), depending on what type of fund it is. Trained financial analysts make the investing decisions and units of the fund can be bought and sold so that even if a fund is investing in a 10 year bond, investors are not tied to the fund for any fixed period.
What are the different types of mutual fund?
Different mutual funds cater to the different risk profiles of investors. Some investors are not prepared to risk their capital being lost and so will only invest in products where their initial money (capital) is protected. Others will invest in stocks and shares (equity), knowing the value of shares can go down as well as up but willing to take that risk for the greater returns that equity offers. Some investors will want a combination of equity and fixed income and there are funds that cater to that.
We spoke to Ali Alvi, Chief Strategy Officer of JS Investments who explained about the different types of mutual fund they offer. JS Investments is the oldest private sector asset management company in Pakistan and manages funds worth 22 billion rupees.
Fixed Income Mutual Funds
These invest in money market products, such Treasury Bills which are short term loans to the government, and in longer term bonds issued by the government, banks and top companies. You can have fixed income funds that invest purely in the money market, ie short term loans only, while others concentrate on mid-term and long-term securities.
With Fixed Income Mutual Funds, your capital is protected and you will earn a higher return than you would on average with a term deposit at a bank. A fixed income mutual fund is also more liquid than a term deposit – you can buy and sell units of the mutual fund but you can’t break a term deposit at a bank without incurring a penalty. A saving or checking account at a bank gives you complete flexibility to withdraw your money at any time but the returns are much lower.
Presently the return for Money Market funds is around 10% for conventional funds and a little lower, around 8 or 9% for Islamic funds.
Equity funds invest in stocks and shares. They are much safer than investing in a single stock or share as your money is spread through the basket of shares that the fund invests in. Investment decisions are made by a trained team of analysts,
“At JS investments we not only look at the financial model of the company and analyse its financial statements, our analysts look at the industry as a whole and visit the companies to assess the business so that our investment decisions are as educated as possible.”
Equity funds on average have a return of 18% but can in tough years have a negative return as well. In 2018 the regular equity funds had a return of -15% whereas Islamic funds had a return of around -11%. However, in 2016 some funds went up 46% in one year. Remember the value of the fund can go down as well as up. If you’re investing in equity you should be taking a long term view, investing for at least 2 years but preferably 5-7 years.
Combination funds have a predefined split between equity and fixed income, for example 50-50% or 30-70%, so investors can save according to their own risk profile.
What should your risk profile be?
How much risk should you take with your savings? Well it depends on your circumstances and your age. If you really can’t afford to hold on to an equity fund that has depreciated or that isn’t giving you an income, then stick to fixed income products. If you’re young and have disposable income, pop some money in an equity fund instead of splurging on a designer item. As a rule of thumb, a twenty-year old might keep as much as 80% in equities but someone in their 50s who is approaching retirement may prefer to have only 30% in equities, with the rest in fixed income funds where your capital is protected and you have a guaranteed return. Someone in their sixties should ideally have no equity exposure and new investors may like to start with fixed income funds until they get used to the concept of mutual funds.
How safe is your money?
Mutual funds are managed by asset management companies, which are regulated by the SECP, but they never actually HOLD your money. All funds are structured as trusts with the Central Depository Company (CDC) as trustee and custodian. The CDC’s primary function is as a record keeper – it doesn’t own the fund which is an independent entity held in a trust. That means the fortunes of the asset management company have zero impact on the fortunes of any fund they manage. Similarly if one fund, for example an equity fund, has a bad year, this doesn’t affect any other fund as each fund is independent.
If you prefer Islamic Banking and Islamic investing as opposed to conventional financial instruments, there are many Islamic mutual funds available. Ali of JS Investments explains,
“There is an Islamic counterpart to every conventional fund we offer, investing in Islamic Money Market or Islamic Equity. Al-Hilal Sharia advisers approve the documentation and pre-approve the type of investment avenues permitted, for example Sukuks. They then monitor the fund regularly to ensure that it is sharia-compliant.”
What are the fees?
Asset management companies charge a management fee of about 2% a year on equity funds and 0.15% a year on money market funds. The fees are charged on a daily basis and built into the price and there are on entry and exit fees to pay when you buy and sell mutual funds. Certain specialised classes of mutual fund such as capital preservation funds can have front-end or back-end fees but you will always be informed about these in advance.
Are there any tax benefits?
This is where mutual funds give you a big advantage. The government gives you a tax credit on up to 20% of your taxable income if it is invested in mutual funds, up to a maximum of Rs2,000,000. So what does that mean? You can invest up to 20% of your income in a mutual fund and you will not have to pay any tax on that 20%. The amount you can claim tax credit on is capped at Rs2 million so if you are a higher rate tax payer (paying 25% tax) you can invest Rs2,000,000 in a mutual fund and save Rs500,000 tax. You must stay invested for two years but the tax credit is immediate and if you are a salaried employee, you can give your mutual fund account statement to your HR department and they can adjust your tax credit amount from your monthly income tax deductions.
How easy is it to invest in a mutual fund?
Application forms are simpler than a bank account form. You need to provide your CNIC and some Know Your Customer info and that’s pretty much it. At JS Investments, you can call their helpline on 0800 008 87 to arrange a meeting with their salesperson or walk into the office. The initial investment must be done in person, after which you can use their online portal or mobile app to manage your investment. You get an electronic statement on every transaction and fund prices are announced on a daily basis – both on the asset management company website and on the MUFAP website.
So there you have it – personal investing 101 for Pakistani investors. Take some time to explore the options and take control of your own savings!