Practical Stewardship – Managing Our Investment Risks (Part 2)

by Seph Romana

Probably the most common form of investment for Filipinos is the Bank. For this reason, we shall dedicate part 2 to differentiating the more common investment products offered by banks as well as their advantages, disadvantages and red flags to watch out for that may indicate high risk of loss.

DEPOSITS

Probably the most common type of investment for most Filipinos, deposits are actual LIABILITIES of banks, i.e. they are considered borrowed money from us depositors. Bank deposits are a fixed-income type of investment because of the guaranteed interest rate promised by banks that are paid periodically or upon maturity of the deposit. Our deposits are insured up to a maximum of P500,000.00 by the Philippine Deposit Insurance Corporation (PDIC) where individual and joint accounts are treated separately for insurance purposes (http://www.pdic.gov.ph/index.php?nid1=7&nid2=2&rid=49).

Advantages include having a fixed return (interest earned), high liquidity (ease of withdrawals and fund transfers or bills payments) and security of up to P500,000.00 (PDIC coverage).

The major disadvantage of deposits as an investment is that the interest rates are usually so low that often times, our money actually shrinks over time due to inflation (the rate at which prices of goods increase).

How is this? If we deposited P100 now at 3% per year, it will be P103 at the end of one year. Let’s assume further that today, a kilo of rice is only P50, which means our P100 can buy exactly 2 kilos of rice. If the inflation is 4%, the price of 2 kilos of rice 1 year from now would be P104 (P50/kilo X 2 X 1.04). A year from now, our P100 investment actually lost value as it can only buy less than 2 kilos of rice given the inflation rate.

Red flags to watch out for are extremely high rates compared to prevailing deposit rates of other banks, payment of “advanced” interest and outrageous freebies like cellular phones and the like. The principle behind this is that the interest rate is the price of borrowing money. A person who is in desperate need of funds is willing to borrow from a loan shark at exorbitantly high rates because he or she can’t borrow from lower priced sources like banks.

The same can be said of banks that are experiencing problems. The greater the need for funds an institution has is the extent it is willing to raise interest rates on deposits and offer things most banks normally wouldn’t. If an institution is experiencing liquidity problems, the more it will resort to exorbitantly higher rates and abnormal promos just to entice us to deposit our money with them.

As such, credit risk of such banks is heightened. So if for example, most banks are offering an average of 2-3% on deposits but a bank is offering 15%, that is a red flag to consider.

Nest Egg - Savings

GOVERNMENT SECURITIES

These are “promissory” notes of the Philippine Government sold by banks’ treasury and trust departments. These include treasury bills and treasury bonds and these pay interest to investors. As these are borrowings of the government, banks only act as middlemen and are thus not directly liable to investors. They only facilitate the payment of interest and principal as well as safekeeping of securities on our behalf. These are not insured with the PDIC.

Advantages include being credit-risk free (for peso denominated government securities as these are guaranteed by the national government) and higher interest compared to bank deposits particularly for longer tenured government securities. Disadvantages may include higher liquidity risk than bank deposits and lower returns than those of stock market or mutual fund investments.

UNIT INVESTMENT TRUST FUNDS (UITF)

UITF or Unit Investment Trust Fund is a collective investment scheme offered by banks wherein money from various investors are pooled together into one fund to achieve a specific investment objective. UITFs are very good investment vehicles for people who have no time or expertise to do actual stock or bond trading since professional investment managers are the ones managing the fund. – PinoyMoneyTalk.com (http://www.pinoymoneytalk.com/how-to-invest-in-uitf/).

Banks’ fund managers invest the funds in different instruments like stocks and/or fixed income securities (government securities or commercial papers). These however, do not earn interest. Investors earn through capital appreciation when the value or price per unit increases over time.

And similar to direct investments in government securities, these are not direct liabilities of the issuing bank as they merely pool and manage funds for us investors. Like government securities, these are not insured with the PDIC.

Advantages include high liquidity, possibly high returns compared to bank deposits and direct government securities investments and professional investment management. Disadvantages include non-guaranteed returns with possible losses when financial markets in general are not performing well.

As such, banks cannot guarantee returns on UITFs but can only give us an idea of how their UITFs have performed in the past. If they guarantee such returns, either they don’t know what they are doing or they are not being truthful to us. Either way, we must consider guaranteed returns on UITFs a red flag.

On Part 3, we’ll take a look at stocks and businesses.

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