The idea of mutual funds is simple – investors contribute money into a common fund that is then invested on their behalf.
Key Takeaways
- Multiple investors contribute money to a common fund.
- The fund is then invested by a Mutual Fund Manager.
- Relatively low-risk investment alternative.
- Their benefits depend on your investment needs.
The funds are invested in specific assets (stocks, money market instruments, bonds, and other related assets) with the primary goal of gaining value over time (capital gains).
Also, not every Tom, Dick, and Harry makes the investment but rather a set of finance professionals (fund managers).
Bringing it locally, the common mutual funds in Kenya include Cytonn Money Market Fund, Britam Money Market Fund, Zimele Market Fund, CIC Money Market Fund, and KCB Money Market Fund.
There are a dozen companies behind other mutual funds including almost all insurance firms in Kenya.
A crash course on mutual funds
While there is a lot of technical jargon around mutual funds, they all seem to follow the same framework of operation – minimize risk, pursue a high interest, and earn commissions.
A mutual fund manager has the option to invest either in the money market, the dividend market, or the balance between the two.
The option chosen is largely guided by risk (low, medium, and high risk) and the payout timings.
On payout, short-term funds usually work for investors who need their money regularly or consider it as an income within the year while long-term funds can run more than 5 years before a payout.
Money Market funds | Carry the lowest risk and can easily act as a way to accumulate money for savings, investments, school fees, etc. |
Dividend funds | Carry moderate risks and equally a higher payout than money market funds. They constitute stocks with proven track records, government instruments, money markets, and some corporate bonds. |
Balanced funds | A mix of both money market funds and dividend funds. Have a significantly higher payout rate. Balanced funds are long-term and mostly for retirement benefits. |
From the investors’ side, the general floating assumption is that mutual funds carry lower risks.
Past this assumption, the focus is to get a fund that suits your money needs, that is, befitting when you will need the money back and how often you may want to get paid the capital gains. This is what is referred to above as the payout consideration by mutual fund managers.
Why do people invest in mutual funds?
Well, first, they are marketed too well and fund managers are very convincing to potential investors.
Some good benefits of joining funds include:
- Professionally managed investments
- Access to diverse investment options
- Diversifying your portfolio
- Lower transaction fees/brokerage fees
- Economies of scale are realized by using the fund to navigate into otherwise inaccessible stocks.
Besides these benefits, people are afraid to invest on their own and would rather trust someone else (the fund manager) to do it.
And since the fund managers know this, they will convince any potential investor (who is considering investing on their own) along the lines of;
You don’t know what you are doing
You lack the experience
It’s better to leave investing to the professionals
You cannot navigate and beat the markets
You cannot get the best returns on your own
If it’s hard to even for professionals why would you think you can do it?
And this works 99% of the time.
Increasingly less desirable
The curious part of mutual funds is that they are increasingly becoming unconvincing based on poor comparative performance with other market instruments and investment alternatives as well as due to the weight of mutual funds companies and their commissions.
Let’s start with performance.
It makes little sense to get give someone (mutual fund) Kshs 50,000 to invest for you in the Safaricom stock and then share the dividends at the end of the year instead of just investing the sum for yourself and keeping 100% of the dividends.
Of course, this is an overly simplified version of mutual funds vs self-investment but it still applies even in the more complex scenarios.
Capital gains via mutual funds tend to be less than similar gains outside the mutual fund. This scenario has been proven severally in the U.S. context where mutual funds had consistently lower interest rates than FTSE Indexes.
Secondly, we have mutual fund companies and their commissions. On this, the famous Warren Buffet said;
“Professionals in other fields, like dentists, bring a lot to the layman, but people get nothing for their money from professional money managers.”
The argument by Warren Buffet is that fund managers do not add any significant value but still charge commissions for it.
The ideal case is that if you can grow your Kshs. 50,000 to Kshs 70,000 a year alone, then a fund manager should be able to grow the same Kshs. 50,000 to Kshs. 80,000 for them to argue that they are helping you.
The age of information and the financial revolution
It is also worth noting that the ability to make a good investment is accessible to the average Kenyan now more than ever.
Over the past few years globally, access to information has accelerated and this is not different for investment in financial instruments. In fact, most people in Kenya buying stocks go to stockbrokers directly as opposed to using mutual funds.
Phil Town, a popular hedge manager explains this financial literacy with a story. I’ll paraphrase;
Consider a small village where only one guy knows how to read and write.
This guy reads and writes letters for everyone in the village at a fee as he facilitates communication with the outside world. Other people interested in reading would ask the guy to show them how it is done but he would pick the most complicated book and confuse them with its contents.
Anyone interested in reading and writing would go back sulking and leave it to the main guy. It didn’t help that to be like that guy, other people would need to invest in learning and a teacher and this would be costly and not a guarantee of success.
However, there comes a technology that puts books in the hands of everyone and a system that teaches them how to read. Soon enough, everyone is doing it and that guy’s business collapses.
The notion that the average person can trade well enough is gaining traction due to the financial revolution and access to information.
So, are mutual funds in Kenya worth it?
This is the kind of question with a yes and no answer.
No, because it may be an additional cost (via commissions and fees that you pay) to your investment that ultimately becomes unnecessary.
This is especially if you are literate enough to educate yourself on how to trade stocks and other financial instruments and also consider yourself a young and small investor.
In fact, unless you are floating in the tens of millions, mutual funds should not be your first option at investment.
Yes, because not all of us want the hustle of managing our investments.
Mutual funds make great sense to multi-millionaires and above because once they deal with the mutual fund manager, they can go back to their day-to-day lives without the hustle of constantly checking on maybe 8 financial instruments (under different brokers and institutions) and how they are performing.
It is also doubtful that mutual funds in Kenya are much concerned with individual investors given that a bulk of their investors are corporate institutions.
But overall, if your wealth is at the level of having to hire someone else to manage your investment portfolio in financial instruments, then they could be definitely worth it for you.
Note
The information provided in this article is not investment advice. Please consult a licensed professional for guidance on how to invest in mutual funds.