The Asian financial crisis of 1997-98 shook many Malaysians to the core. How could an emerging economy that was booming, suddenly come to an abrupt halt?
Many people were left reeling from the overnight crash in the economy. They were not prepared. They did not have contingency funds and most were spending more than they were earning. And if there were investments made, they likely did not have a portfolio that was hedged against sudden loss.
The financial crisis has taught us many lessons; lessons we can utilise to protect ourselves from the next crisis. Since the last crisis was not too long ago, we know it can happen again and soon. Here are 5 reasons why mutual funds can shelter you from a potential financial storm:
1. Quality trumps quantity
Investing your money is a great step towards achieving financial freedom but most importantly, what should you invest in? Investing in unit trust funds is not just about choosing the funds that yield the highest return.
If you’ve invested in a new fund with no track record that you may think will perform well, you have a far worse chance of surviving a financial crisis than you do if you invest in a well-known fund that is managed by a reputable fund manager who will know what to do with his/her portfolio should a crisis emerge to protect the funds.
It’s not just about how much you are investing but what you are investing in. Quality reigns supreme.
2. Cash is king
Unit trusts are investments that allow investors to keep their investments relatively liquid. They can easily invest and redeem as they see fit.
The key to successful financial planning is to establish healthy cash flow. Nothing beats the flexibility of cashing out from an investment whenever you need to. Unlike investing in properties, you can easily cash out from a unit trust without going through a long and arduous process.
During bad times, your property investment can go south, especially if you are unable to lease it or sell it and you would be stuck with an asset that can’t be transferred into cash in your time of need.
3. Strategic diversification
The first thing most investors learn of is diversification. The wider the spread of investments is, the less susceptible to volatility your investments will be. Unit trust funds have always been the go-to investment for those who are less risk tolerant as an easy method to diversify their investment risks.
However, diversification must be done strategically to protect yourself against any potential financial crisis while still reaping the most returns.
It can be difficult to achieve true diversification by investing directly in the stock market, especially if the initial investment capital is low. With just RM5,000, it will be difficult to gain a diversified exposure to the property market, global equity market and bond market. But with unit trusts, it is possible to spread your money around to all of these asset classes at the same time even with low start-up capital. This is because fund managers generally have a large pool of money at their disposal.
4. Bonding with bonds
Investing in bonds is basically lending your money to corporations or governments. It makes sense to only lend your money to someone that will pay you back. The same goes to investing in bonds – you should only invest in a bond that has good ratings ratings or leave it to the bond fund managers.
These bonds will be resilient throughout a crisis and continue to provide a steady income. However, if they do go bust (though highly unlikely with good quality bonds), the priority of compensation goes to the bond investor rather than stocks investor.
Historically, stocks have always outperformed bonds in the long run, but by including bonds in your investment portfolio, it can help smooth out the bumps when recession comes around.
Bonds can contribute an element of stability to almost any portfolio because they are safe and conservative and provide a predictable stream of income when stocks perform poorly.
5. Insulate yourself from inflation
When you were in primary school, you might have been getting by with just RM2 daily allowance but today, primary school children will need at least RM5 a day. This is the result of inflation.
If you are unable to protect your money against inflation, there is very little chance you can weather a financial crisis. You cannot stop inflation but you can beat the game by putting your money somewhere it can grow faster than inflation.
Malaysia’s inflation rate rose 3.5% in March 2014 from a year ago, which was in line with economists’ expectations. Hence, to protect your money, you need to put it in an investment that offers interest rate that is at least higher than 3.5% reliably.
Malaysia is fortunate enough not to experience natural disasters such as hurricanes and earthquakes, but if a hurricane were to head your way, would you leave your window open or reinforce your window with steel bars?
The answer is obvious and when it comes to financial crisis, your answer should be the same.
Before you brush aside unit trust and bond investment, consider your current portfolio and ask yourself, if it can withstand a few economic punches or will you end up as a victim of a financial crisis?
Don’t wait for a crisis to happen before acting. Start evaluating your portfolio now to protect yourself and your family!