Friday, July 20, 2018
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Intelligent Investing

Gaining exposure to the stock market through mutual funds

Should you consider buying mutual funds to gain exposure to the stock market? I believe so. Even though I am knowledgeable in picking stocks, I still buy equity mutual funds occasionally to gain exposure to the stock market. Here are the reasons why.

No stock picking required. This is the most compelling reason why you should consider buying mutual funds—It takes away the complicated business of having to pick stocks to gain exposure to the stock market, which is one of the main reasons why people who want to invest in the stock market do not invest. For example, if the recently announced 6.8-percent first-quarter GDP growth of the Philippine economy convinced you to invest in the stock market, but you don’t know which stocks to buy, then you can just buy an equity mutual fund.

Buying equity mutual funds is perfect for busy individuals such as working professionals who don’t have time to do research on which stocks to buy. Just buy an equity mutual fund and let the fund manager handling the fund do the stock picking for you.

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Automatically diversified. By design, equity mutual funds own a basket of stocks in their portfolios as a means to reduce risk and to better track the performance of the stock market. In fact, equity index funds (which is a type of equity mutual fund) have exposure to all 30 stocks in the PSEi since their main objective is to replicate the performance of the index. By buying an equity mutual fund, you automatically gain exposure to the fund’s diversified portfolio.

You can also buy mutual funds to execute a core-satellite investing strategy. In a core-satellite investing strategy, the investor allocates a small portion of his portfolio to buy his favorite stock picks, which may be too few to create a diversified portfolio. He then allocates the rest of his portfolio to buy an equity index fund to gain full exposure to the stock market. For example, assuming that I was able to convince you to buy stocks of cement companies (which I featured in last week’s column), but you don’t know what else to buy, you may allocate around 20 percent of your portfolio to buy cement stocks and the balance of 80 percent to buy an equity index fund.

Appropriate for small portfolios. Nowadays, you can open a stockbrokerage account with only P5,000, which makes investing very affordable and accessible. However, creating a diversified portfolio by buying individual stocks is impossible with P5,000, which is a major challenge facing small investors. However, even if you only have P5,000, you can already gain exposure to a diversified portfolio of stocks by buying equity mutual funds. In fact, after the first P5,000, you can slowly increase your exposure to the stock market by making additional placements in equity mutual funds of only P1,000 at a time.

Personally, I buy equity mutual funds for my children who give me the money they receive during Christmas and birthdays as well as the money they save from their allowance. Equity mutual funds are perfect for them since they only invest small amounts of money at a time.

Appropriate for big portfolios. While equity mutual funds are appropriate for small portfolios, they are also appropriate for high net worth individuals with big portfolios worth millions of pesos. It is quite unfortunate that a lot of stocks in the PSE are illiquid, meaning they are not actively traded. This makes it difficult for large investors to buy millions worth of stocks right away without having to pay a premium. Problems with liquidity also make it difficult for large investors to liquidate a huge amount of stocks immediately without having to sell at a discount. To avoid buying at a premium and selling at a discount, investors with big portfolios have to execute their orders slowly, which can be very frustrating sometimes.

An investor with a big portfolio can address this problem by buying equity mutual funds to gain an immediate exposure to the stock market. He just needs to enter his order and the fund manager handling the fund he bought will take care of buying the stocks for him.

With the reasons provided above, I hope that you now understand why you should consider buying equity mutual funds to gain exposure to the stock market.

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