Tuesday, December 27, 2011

GMA 7 is on MVP's Christmas Wish List


Are You Ready for the "Kaputid" Network?

I got this off one of my contacts in Facebook. Rumor has it that Manny V. Pangilinan, a.k.a. "MVP", has made an offer to the Duavit, Gozon, and Jimenez families for GMA 7, and that the offer figure is so "mind-boggling" that it's "impossible to counter." And if you think Ruffa Gutierrez is a reliable source, then it seems that this already is a done deal.

Haven't we seen a similar move from MVP months ago with the PLDT-Digitel merger? If the offer is true and if a deal does materialize, it would be interesting to see the following unfold in the next few days:

  • How much premium MVP is willing to pay to own the undisputed number one network in the country
  • If ABS-CBN would go the same way as Globe and try to block the deal (and how much political clout the Lopezes still have left)
  • How the stock prices of affected players (e.g., PLDT, GMA, ABS-CBN) would be affected 

If the offer is indeed as high as rumored, then we should see significant short-term gains for GMA (up around 5% as of this writing) and possibly a short term drop for PLDT (down around 0.08% as of this writing). If the tremendous growth of TV5 since MVP took control in 2008 is any indication, then a GMA7-TV5 "alliance" should eventually bear significant fruits in the long run; whether this additional value is worth more than the premium paid for the acquisition is another question altogether.

As for ABS-CBN, just like with Globe in the PLDT-Digitel merger, some would argue that the move will also benefit the second player since industry consolidation would decrease competition for the entire industry and all its players. Frankly, I'm not a really big fan of the network and I think I pretty much loath everything the "kapamilya" network comes to represent. Ever since the Lopezes regained control of ABS-CBN in 1986 from Marcos's cronies, it had been in the best position to innovate and provide high quality entertainment for Filipinos, but what it did in the next 25 years was serve regurgitated crap that just made everyone dumber. Anyway, enough about that; I just hope that with this additional pressure will force ABS-CBN finally try to live up to its promise.


UPDATE 28 December 2011, 2:22 PM via PhilSTAR.com

GMA has just denied the rumor:

“There is no truth to the rumor ongoing around in social media sites and the Internet that Mr. Pangilinan has bought GMA Network. In fact, there is no negotiation going on between GMA and Mr. Pangilinan regarding the latter’s acquisition of GMA-7.”

And now we know what the rumored "mind-boggling" offer is: 500 billion pesos, or 25 times GMA's current market capitalization of around 20 billion . Wow. Yeah, that can't be right.

GMA 7 shares are down around 0.5% today.

Saturday, December 24, 2011

1st Annual Holiday Rant 2011: Societal Trust

Episode One: Robinson's Pioneer

After spending a couple of days in Manila to meet some friends, I asked my sister to pick me up and take me to our parents’ place in Bulacan. I would have gone on my own, if I could, but I had this sealed big box of presents with me from Hong Kong. I already anticipated that I might be hassled by the guards when I enter the mall with all my stuff, but I really hoped that I would be able to charm them or at least reason with them.

As it turned out, I did not have any problem going inside the mall: I was able to reassure the lady guard that I was just carrying a box of gift toys and sweet talk her out of asking me to open it. Unfortunately, this same strategy turned out to be ineffective with another guard that I encountered a bit later. As I was waiting for my sister near the exit to the parking lot, another lady guard approached me out of nowhere and asked what I had in the box. In my sweetest tone, I answered “toys for my nephews and nieces” and explained that I already talked to the other guard about it. Still, she insisted that I open the box, and since by then I was already too tired to argue, I promptly ripped the box open (it was sealed, and I did not have a knife or any sharp object with which to open the box properly). When she saw the various boxes of toys inside the bigger box, she walked away with nary a word (I can only imagine how it would have turned out had I wrapped my gifts before flying to Manila).

Episode Two: SM Marilao

The other day I went out for last-minute gifts. I quickly bought a couple of Transformers movie toys from Toy Kingdom, then headed to the supermarket for a few supplies. As I was about to enter, the guard nonchalantly stopped me and asked me to “check in” my Toy Kingdom plastic bag. I was really surprised that she asked me to do this—the bag was small as it only contained two card-backed Transformers toys—so I asked her why I had to do this. She simply said that my toys might get mixed with my other purchases—or something to that effect—but instead of saying “so what?” as I probably should have, I just walked away.

So what?

I was not really angry at these guards: while some guards could really turn up the power trip at times, ultimately they’re still just doing what they were told by higher ups. Well, maybe I was a bit pissed, not at them, but at these attempts to improve security and address threats to peace and order, because by now we all know that these efforts don’t work and just waste people’s time and resources; these policies were presumably designed for our benefit and interest as ordinary Filipinos but in truth are implemented at our expense. But mostly I was saddened because I realize that these practices just end up sowing a deeper, darker cloud of mistrust in Filipino society.


According to Francis Fukuyama,

“A nation's well being, as well as its ability to compete, is conditioned by a single, pervasive cultural characteristic: the level of trust inherent in society.”

The successful consummation of every economic transaction is heavily dependent on how each party trusts the other to behave as expected since contracts can only address so many details and possibilities. Trust can also provide significant additional value to businesses by minimizing transaction and monitoring costs. So maybe it’s no coincidence that some of the most developed countries in the world trust their citizens enough so that individuals are not asked to open sealed boxes inside malls or open bags when entering train stations.

Some of you may point out that it’s a small price to pay for security—or at least, a sense of security—and I will have agreed if indeed these policies make us feel safer, but they don’t. Some of you may say that I’m just being petty and making too much fuss about nothing and I will have agreed were the amount of economic resources wasted on such practices trivial, but it isn’t.

I’m not trying to be a defeatist or an alarmist, because really, if this season means anything to me, it’s that things can always get better and that sometimes they do. Maybe what this post is really about, apart from being a venue for my rant, is how to convince ourselves to try to trust each other more, because really, no matter how bright and honest our president and all our leaders are, as long as we don’t trust the ordinary Filipino enough to just leave him be, let him do his business, and not think he will shoplift or set a bomb at the next opportunity, our nation will find it very hard to become great again.

Of course this is only possible if we become more trustworthy ourselves. Trust and trustworthiness is a chicken and egg thing, although knowing which one comes first matters less than actually getting the cycle started.

And it starts with me, of course.

Happy holidays, everyone. :)

Thursday, December 22, 2011

Watch "Inside Job" Online, For Free

I already mentioned this Oscar-winning documentary about the 2008 subprime crisis in a post a couple of months ago. If you have not seen it yet, here's your chance to (legally) see Inside Job online for free, and in high definition.

The film remains importantly relevant to this day as we find ourselves on the cusp of another potential global financial crisis.

Link for Inside Job (can't be embedded, unfortunately)

After watching, we can discuss the film in the comments section below.

Friday, December 16, 2011

5 Reasons Why the Philippines Will Fare Relatively Well in Another Financial Crisis

Last week, I attended a seminar entitled "Can Emerging East Asia Weather Another Global Economic Crisis?" "Emerging East Asia" pertains to the ASEAN 10 (Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Burma, Cambodia, Laos, and Vietnam), China, Taiwan, Korea, and Hong Kong. Key participants included Mr. Iwan J. Azis, head of ADB's Office of Regional Economic Integration, and representatives from the International Monetary Fund (IMF), the Hong Kong Monetary Authority, Barclays Capital, and the Korea Institute for International Economic Policy. In this post, I will highlight important insights that I gathered from the event and how these will affect the economic prospects of the Philippines in the coming years.

Mr. Azis opened the seminar with a presentation of key points from the Asia Economic Monitor for December 2011. ADB sees that if the debt problem in Europe is not resolved and contained in the coming weeks and months, it may lead to any of the following three scenarios: first, a recession contained to the Eurozone; second, a recession in Europe and, to a lesser degree, in the US; and finally, a full-blown global financial crisis.

Just as in 2008/2009, any one of these situations could result in heightened risk aversion among investors and a sharp drop in global demand for goods and services that would, in turn, adversely affect countries from emerging East Asia to varying degrees. The extent of the damage to any particular economy and the capacity of that economy to recover from the crisis will greatly depend on the following factors:

  • The "health" of the financial/banking sector and its exposure to toxic assets
  • The economy's exposure to European and US banks
  • The economy's dependence on foreign demand (i.e., exports) vis-a-vis local demand
  • The capacity of the economy to enact timely policy responses
In the worst case, ADB forecasts that regional growth will go down by 1.8 percentage points, assuming no policy response from the concerned economies.

How will the Philippines fare compared to other emerging East Asian economies? 

There are indications that the Philippines will fare relatively well in an impending financial crisis.

1. The Philippine banking sector remains conservative, and this will continue to shield us from the brunt of any financial crisis, just as it did in 2008. Also, efforts by the BSP to impose stricter capital requirements, particularly for thrift and rural banks, in the past couple of years further strengthen the banking sector as a whole.

2. The Philippines has a lower exposure to European and US banks compared to other countries in the region.

3. The Philippines has significantly reduced its reliance on US and European trade in the past couple of years.

4. Philippine households have remained financially conservative, especially compared to other economies in the region. Of course, the figures below most probably does not capture informal debt, and so may be understated.

5. (This is just my opinion) The Aquino administration's efforts to hold the previous administration accountable for past transgressions has and will continue to lead to stronger investor confidence.

Although no one particular country was discussed in the seminar, this final slide from ADB clearly supports the conclusion that the Philippines will fare relatively better than other economies in the region in a global economic crisis scenario.

Which should be very good news for most of us, although I'm not particularly ecstatic about all this since most of my investments are here in Hong Kong. Oh well, I guess I would just have to boost my Philippine holdings as much as I can.

As for the question "Can Emerging East Asia Weather Another Global Economic Crisis?", Mr. Azis' answer was straight to the point: "Yes, but we have to prepare for the worst."

And here's a gratuitous shot of Hong Kong harbour from the event location.

Tuesday, December 13, 2011

Decision Making According to Economists, Part 2: Diminishing Marginal Utility

Let's go back to where we left off in Part 1.

In a game of chance, you pay a fixed fee to enter, and then a fair coin will be tossed repeatedly until a tail first appears, ending the game. The pot starts at 1 peso and is doubled every time a head appears. You win whatever is in the pot after the game ends. Thus you win 1 peso if a tail appears on the first toss, 2 pesos if on the second, 4 pesos if on the third, 8 pesos if on the fourth, etc. In short, you win 2^(k − 1) pesos if the coin is tossed k times until the first tail appears.

What would be a fair price to pay for entering the game?

We can estimate the "fair price" of this game using expected value, for which we need the payoffs and probabilities that correspond to each state of nature.

The game could end after the following number of tosses:

1   2   3   4  5   ...   k   k + 1   ...

Please note that it is possible (although, of course, very improbable) that the game would go on indefinitely.

The payoffs for these possible outcomes are as follows:

1   2   4   8   16   ...   2^(k -1) ...   2^k   ...

Now we turn to the probabilities. For the first outcome, the probability of getting a tail on the first toss is 1/2. For the second outcome, you'll need to toss heads then tails, for which the probability is 1/4. The third outcome consists of heads, heads, and tails, and the probability is 1/8. So now, we should see that the pattern of probabilities is:

1/2   1/4   1/8   1/16   1/32   ...   1/(2^k)   ...   1/(2^(k + 1))   ...

The expected value of an alternative is just the weighted average of the payoffs, using probabilities as weights. Therefore, the expected value of playing the game is:

1*1/2 + 2*1/4 + 4*1/8 + 8*1/16 + 16*1/32 + 2^(k - 1)*(1/(2^k)) + 2^k*(1/(2^(k + 1))) + ...
= 1/2 + 1/2 + 1/2 + 1/2 + 1/2 + 1/2 + 1/2 + ...
= infinity

(Kudos to reader "Maykee" for getting it right, and thanks to everyone who tried.)

So, would you pay that much to play the game? How about something significantly less than infinity, like say, 1 million pesos? It does not sound so attractive, right? In fact, I'll bet that you'll even have trouble finding someone who's willing to play the game for 100 pesos (how many tosses would it take to win more than this?). This is why people have referred to this game as a paradox--the St. Petersburg Paradox, to be precise.

The game was invented by Nicolaus Bernoulli, nephew of the Bernoulli that we encountered in Part 1. "St. Petersburg" does not pertain in any way to Nicolas, however, but very interestingly to the work of another famous Bernoulli, his cousin Daniel. According to Daniel Bernoulli, it is not appropriate to use expected value to solve the problem since

The determination of the value of an item must not be based on the price, but rather on the utility it yields…. There is no doubt that a gain of one thousand ducats (some form of ancient money) is more significant to the pauper than to a rich man though both gain the same amount.

Daniel Bernoulli
What is utility? In its most basic sense utility is the satisfaction or benefit that one gets from choosing or doing something. Economists want to play safe, however, and just say that utility is that something which makes decision makers choose one thing over another. And Daniel Bernoulli's simple idea--that of diminishing marginal utility--revolutionized the study of economics and decision making in the next couple of centuries.

Diminishing marginal utility means that the utility that one gets from receiving or consuming one unit of something--be it pesos, ducats, fame, or beer--decreases as one amasses more and more of that something. It explains why the first bottle of beer tastes oh-so-much better than your fifth, and why receiving a 5,000 peso bonus when you're just earning 10,000 pesos a month is more satisfying than receiving the same amount when you're already a millionaire.

This concept is also very important in finance because it defines a decision maker's attitude towards risk. An individual for whom a particular reward has diminishing marginal utility is risk averse with respect to that reward: he or she is the stereotypical decision maker in economics, someone who is willing to pay to avoid a very small probability of a big loss (e.g., someone who buys insurance)--that is, how most of us usually are. Someone for whom the same reward has increasing marginal utility, on the other hand, may be seen as risk seeking, like someone who will pay just to have even a small chance of winning something big (e.g., someone who plays the lottery)--that is, how most of us are in certain situations, sometimes.

Going back to the game, if we assume that for a typical player the game's prize has diminishing marginal utility and that this utility is a slowly increasing function of the player's initial wealth plus his winnings, then the utility of the additional payoff from a toss of heads will be smaller than the utility of the one that came before, which should result in a finite fair price.

I know a lot of you have already had your fill of theoretical mumbo jumbo this past month, so we'll get back to more practical matters in the next post. :)

Thursday, December 8, 2011

Life Insurance


Dear Investor Juan,

I am writing to you because I'm somewhat new to this financial literacy thing and I want to know if it is possible to know your two cents about life insurance? Almost all the articles I've read about financial literacy says that the first step is getting protection (life insurance) or maybe after budgeting and saving but before investing. I think you've already scratched the surface about this topic on some of your articles. And from what I understand, you prefer term over traditional and VUL or "buy term invest the difference". Lastly, maybe you could recommend a life insurance product here in the Philippines or what features to look for when getting a life insurance. Again, thank you for your time and God speed on your future endeavors.

Kind regards,


Dear Aaron,

Most probably you have already read my introductory post several weeks ago about insurance, but for the benefit of those who haven't, I will start this post with a definition. In the simplest sense, insurance is a contract between two parties: one party, insurance company, promises to pay specified amounts to the other party, the policyholder, conditional on the occurrence of future events such as death, car accidents, or pirate attacks; in return, the policyholder, pays the insurance company insurance premiums for this transfer of risk to the latter. There are three major types of insurance that we all should be familiar with: life insurance, health insurance, and property and casualty insurance. I will limit my discussion to life insurance in this post and just talk about the other types in future posts.

Life insurance, as the name suggests, insures against death: the life insurance company pays the beneficiary of the life insurance policy in the event of the death of the insured. Life insurance doesn't benefit the policyholder personally, but rather his or her dependents. So in a sense, life insurance would be more important to those with families and other dependents than to those who are single with no dependents.

There are two primary types of life insurance: term life and cash value life insurance. Term insurance is the simplest type: you pay the premium for the amount of coverage that you want (i.e., the number of years and for what amount) and lose coverage when your policy lapses and you choose not to renew. You don't "earn" anything with term life so it does not have any cash or investment value (which isn't saying it does not have any value).

The other class of insurance--cash value or permanent life insurance--is generally a combination of term life insurance and an investment product that has a cash or investment value. Usually, policyholders have an option to withdraw from this value, borrow against it (i.e., use it as collateral for a loan), or just let in mature and receive a "bullet" payment or a schedule of payments.

We can also classify cash value life insurance even further, based on whether the cash value is guaranteed or variable and whether the required premium is fixed or flexible. The four combinations and their general characteristics are presented in the table below.

Guaranteed Cash Value
Variable Cash Value
Fixed Premium
Whole life insurance
- Guaranteed build up of cash value
Variable life insurance
- Policyholders are allowed to allocate their premiums among several investment accounts
Flexible Premium
Universal life insurance
- Greater separation between term insurance and investment components
- Premium payments are flexible, but there is a minimum initial premium
Variable universal life insurance
- Same as variable life but premiums are flexible

Everything looks dandy. So why do I advise against cash value insurance?

In general, I recommend just buying term life and investing on your own for two main reasons:

1. You lose flexibility and liquidity with cash value life. Back in the day when there was just term life insurance, people would buy it for several years, not die, realize that they're just losing money, and eventually cancel the policy. So in the 1800's some guy named Henry Baldwin Hyde came up with cash value life insurance to prevent people from cancelling their policies (since with cash value life, you lose your investment if you cancel too early). With the term life + DIY investment option, you can cash out on the investment part any time you want, even at little or no expense.

2. Cash life policies cost too much. Why? Because you pay someone to do something you can do yourself, arguably better, for much less.

So there. If you think you need it, then buy term life. Investing is a different decision altogether, and in general you'll be better off doing it on your own than getting cash value life. In choosing among insurance companies, I would make a decision based on cost (because term life is basically a commodity--it's the same thing regardless of who it comes from) and reputation.

I hope I was able to sufficiently answer your questions. Good luck!

Tuesday, December 6, 2011

Decision Making According to Economists, Part 1: The Expected Value Criterion

In a previous post, I introduced two approaches in studying how people make decisions. In this post, I will discuss the first of these approaches in greater detail: normative decision making.

The normative or prescriptive approach deals with how people should make decisions: it looks at decision making from the point of view of an ideal decision maker--one who is fully informed, able to compute with perfect accuracy, and fully rational--in a environment where information about all available alternatives are known. The normative approach is generally quantitative and involves formulas that range from the basic to the insanely incomprehensible, and thus usually falls within the exclusive purview of economists and mathematicians. The first important normative decision making criteria--expected value--shall be the focus of this post.

Making decisions using expected value

The scenario below illustrates a typical decision problem

ABC Realty has recently purchased land for the development of a new luxury condominium complex. ABC is in the process of selecting the size of the project that will lead to the largest profit given the uncertainty of the demand for condominiums.

Using the four steps in making good decisions that we discussed previously, let's take a closer look at the details of this problem.

1. Identify all available alternatives. ABC needs to choose the size of the condominium project. Let's say the following alternatives are available:

d1 = a small condominium complex
d2 = a medium condominium complex
d3 = a large condominium complex

3. Identify uncontrollable or unpredictable circumstances that may affect the payoffs of alternatives. The project's profits will be affected by the demand for condominiums. Since these possible occurrences, referred to as states of nature, are beyond the control of the decision maker, they are just assigned likelihoods or probabilities. For example, let's say that according to ABC's analysts, there is an 80% chance that demand for condominiums in the foreseeable future will be strong and a 20% chance that it will be weak, or

probability of strong demand = P(s1) = 80%
probability of weak demand = P(s2) = 20%

It should be pointed out that since s1 and s2 cover all possibilities for the demand for condominiums, P(s1) and P(s2) should sum to 1 or 100%.

2. Determine the costs and benefits of alternatives. Both ABC's choice for the size of the project and the demand for condominiums would affect the project's profits or payoffs, which are presented in the following table

We see from this payoff table that the decision is not straightforward since the best alternative--the one with the highest payoff--changes with the demand for condominiums: whereas a large complex would take advantage of strong demand, it would lead to losses if demand turns out to be weak because of (presumably) the higher cost of construction.

4. Evaluate alternatives using some criteria or rule and make a decision. One commonly used criterion in making a decision given the information presented above is the expected value criterion.

The expected value of an alternative is the weighted average of its payoffs under different states of nature, using the probabilities as weights

This concept was first formalized in Jakob Bernoulli's groundbreaking work, Ars Conjectandi, published in 1713.

Jakob Bernoulli
We compute for the expected value of each alternative as follows

According to this rule, since alternative d3 or building a large condominium complex results in the highest expected value, ABC should choose this alternative.

While the expected value rule does make a lot of practical sense, we should be careful in interpreting the numbers that result from our analysis. An expected value of 14.2 million does not mean ABC will earn that much if it decides to build a large complex: ABC will either earn 20 million or lose 9 million depending on what demand for condominiums will be. 14.2 million is ABC's average profit if it faces this scenario several times and makes the same decision to build a large complex each time; in other words, it's what ABC stands to earn in the long run.

Expected value in practice

The most common practical application of the expected value concept that I can think of is in gambling, particularly in poker. If you play the Texas Hold'em variety or any similar variant, you may have heard of this strategy rule: join the game if the probability of making one of your outs (i.e., your number of outs divided by the number of cards remaining) times the pot is greater than the required bet. The first part of this rule--the probability of making one of your outs times the pot--is the expected value or payoff of joining the game, so if this is higher than the cost of joining, then it makes sense to call the bet.

Something to think about

We'll end this post with something that has puzzled the greatest minds for the longest time until it led to another groundbreaking concept in the study of decision making, which will be the topic of Part 2 of this post.

Think about this scenario for a while.

In a game of chance, you pay a fixed fee to enter, and then a fair coin will be tossed repeatedly until a tail first appears, ending the game. The pot starts at 1 peso and is doubled every time a head appears. You win whatever is in the pot after the game ends. Thus you win 1 peso if a tail appears on the first toss, 2 pesos if on the second, 4 pesos if on the third, 8 pesos if on the fourth, etc. In short, you win 2^(k−1) pesos if the coin is tossed k times until the first tail appears.

What would be a fair price to pay for entering the game? Read Part 2 to find out.

Wednesday, November 30, 2011

Monday, November 28, 2011

How Much Are You Worth? (Part 2)


In Part 1, we talked about why it is important to have an estimate of your worth and how to determine the value--specifically, the market value--of the things that you own.

However, you are not just worth what you own: your potential to generate future earnings--your human capital--is an asset that significantly contributes to your value.

Human capital

In computing for the value of your human capital, you need to have an estimate for the following things:
  • Your total salary and other monetary benefits in the latest year, after taxes. You can include bonuses if you think these will reliably recur year after year.
  • How much your non-monetary benefits are worth per year, excluding SSS/GSIS or any pension plan benefits. These will already be implied in the simple model that we are going to use.
  • Your annual expenses. You can get this figure from your monthly budget plan, if you have one.
  • The rate at which your annual salary (and expenses) will grow per year, on average.
  • Your discount rate, or how much interest rate per year you can earn from your investments, on average. To be conservative, you can just use the prevailing after-tax yield of high-grade corporate bonds, which should be 5 to 6%.
Conceptually, your human capital is just equal to the present value of your expected future after-tax earnings, less expenses. To simplify the computation, we can just assume that you'll get wages practically forever, using your pension in lieu of your salary after retirement, and use the constant growth present value formula.

Human capital = PV of (future annual earnings - expenses)
Human capital = (current annual earnings - expenses)(1 + salary growth rate)/(discount rate - salary growth rate)

Please note that this simplified model will only work if your discount rate is greater than your salary growth rate; if its the other way around, if you think your salary will grow at a higher rate than what you can earn from investments, then your human capital would be infinite which, needless to say, is quite unrealistic. Of course, if you are already familiar with the concept of time value of money, you can always use a more detailed approach in computing for your human capital.

Your assets thus consists of your physical assets (e.g., house, car, jewelry, etc.), financial assets (e.g., stocks, bonds, UITFs, etc.), and human capital. 

Your liabilities are what you owe other people, banks, or other credit providers. It includes your credit card balance, personal loans, car loans, and housing loans, among other things.

Your net worth is just the difference between your total assets and total liabilities; in other words, it's what remains after you have completely paid off everything you owe.

Net worth = total assets - total liabilities

Finally, to better understand how all this works, let's take a look at an actual example.


Pepe is a single, 25 year-old male. His gross salary of 35,000 per month is taxed at 20%, although his 13th month pay is tax exempt. On top of this, he gets additional non-monetary benefits of around 3,000 pesos per month. 

Pepe is quite a frugal guy. On any given month, he makes it a point to save 30% of his after-tax monthly salary and all of his 13th month pay. And because of his hard work, Pepe estimates that his total earnings per year, after taxes and all expenses, may grow by at least 3% per year.

Pepe does not own much. He bought a second-hand car exactly one year ago by paying an 80,000 peso down payment and taking out a 300,000 peso car loan. Today, he owes the bank 250,000 pesos, but he just found out that his car is now just worth 300,000 pesos. Pepe's only other valuable property is a rare toy robot that he received as a gift 20 years ago; the same toy is now selling for around 20,000 pesos on eBay. 

Pepe owns some UITF units, currently worth around 50,000 pesos. The price of this particular UITF has risen by an average of 7% per year in the past 10 years. Pepe also knows how to use his credit card wisely, so he uses it for purchases of around 7,000 pesos per month and always pays the entire balance on time.

Given the information above, what is Pepe's net worth?

Try this out first. I will post my solution in the comments section next week. :)

Thursday, November 24, 2011

How to Make Good Decisions

Contrary to what some of you might think, understanding how people make decisions is an important aspect of successful investing and is thus very relevant to the main thrust of this blog. If we think about it, "investing" really is just a series of "buy" and "sell" decisions, specifically: what assets to buy or invest in, when to invest, and eventually, when to sell. Also, understanding the psychology of the typical investor--how the "crowd" thinks and how it reacts to shocks and new information--is key in devising an effective investment strategy. Finally, the ideas that I present and discuss in this space may actually also be applied to decisions of all kinds, from the mundane (e.g., how to decide which pair of pants to wear today) to the fun (e.g., whether to call, raise, or fold) to the life-changing (e.g., how to choose a wife).

Our aim in discussing and learning these concepts is, first and foremost, to become good decision makers. A good decision is one that is based on logic, and considers all available data and possible alternatives. Please do take note that by "good decision," I don't necessarily mean "the right decision" as no matter how well or systematic one goes through the decision making process, outcomes may still be unexpected or unfavorable. But regardless of the outcome, a decision that is "made properly" is still a good decision.

Normative vs. descriptive decision theories

There are two main approaches in studying decision making: the normative approach and the descriptive approach. The normative or prescriptive approach delves into how people are supposed to make decisions, assuming they are fully informed, able to compute with perfect accuracy, and fully rational--characteristics of an "ideal" decision maker. This approach is generally quantitative in nature and is heavily based on the academic fields of mathematics, operations research, and economics. And because the underlying assumptions of this approach are ultimately unrealistic, many find its associated theories to be of little practical import.

The descriptive approach, on the other hand, deals with how people actually make decisions; it covers the ideas that we have discussed in the Pop Quiz post and is the basis for many important developments in behavioral finance and economics. Descriptive decision theories are mainly based on behavioral and psychological concepts and usually rely on experimental evidence for support.

How does one actually make "good" decisions?

While there is no foolproof way of always getting the best outcomes, it is possible to always make decisions that make sense. Good decisions are those that (roughly) follow these steps.

1. Identify all available alternatives. In poker, each decision stage may be broken down to the following choices: give up and fold, call or meet the current bet, or raise the bet. In most real life situations however, alternatives are not as obvious and clear cut as that; it therefore pays to spend some time to figure out all the alternatives you may choose from, maybe even after some form of initial screening. Nothing is worse than failing to consider what would later turn out to be the best alternative (or even just a really good one).

2. Determine the costs and benefits of alternatives. In finance, when we choose between stocks and bonds, for example, we consider the trade off between the risk of a loss and potential returns. The same is true of most other cases: alternatives entail rewards and costs that we both should consider in making our choice.

3. Identify uncontrollable or unpredictable circumstances that may affect the payoffs of alternatives. What makes decision making so complicated is that it often involves uncertainty, usually about something that may happen in the future that will affect the value of our alternatives. In poker, it is the chance that the river card is a heart that will complete our flush. In investing, it is the possibility that policy makers in the Eurozone will finally get their act together and give stock markets around the world some much needed breathing room. The tricky part is that it is often not enough to know what may happen; most times, having some measure of the likelihood that something will happen is even more important.

4. Evaluate alternatives using some criteria or rule and make a decision. Normative decision theory tells us to use criteria like "expected value" or "expected utility" in making decisions; descriptive decision theory shows us that we don't actually like using these criteria, but rather rules of thumb or heuristics. In most cases, the specific criteria or rule that you use does not matter--as long as you use one. Ultimately, having some basis for making a choice is what separates good decisions from the bad.

Tuesday, November 22, 2011

The Economics of Beauty

It seems that some of you should just stop whatever it is you're doing: it is all for naught. It turns out that beauty and good looks are a significant determinant of happiness and success. According to this study by economist Daniel S. Hamermesh, "plain people" earn less than the average-looking people, who in turn earn less than the good looking ones, regardless of gender. What's more, unattractive women are more likely to be unemployed and marry "men with less human capital" (economist-speak for poor, lazy slobs). Here's Dr. Hamermesh in the flesh, as he discusses this prevalent form of employer discrimination on The Daily Show.

Of course, all this is related to Dr. Hamermesh's other study that shows how more attractive university instructors and professors are rated significantly higher by students. Should I show you how highly my students rated me when I was still teaching? :P

Friday, November 18, 2011

How Much Are You Worth? (Part 1)

Apart from tracking your periodic expenses, it is also important to have an estimate for your net worth at any point in time. While it is common for people to have cash milestones over their lifetimes (who wants to be a millionaire?), it is often more practical to have a "net worth" or "net value" target instead, especially given the significant opportunity costs associated with holding too much cash. Knowing your current net worth gives you an idea of how far you are from your financial goal and how much more you have to work to reach that goal, taking into account how many of us actually owe more than we own (see cartoon above). Also, a net worth estimate gives you a realistic measure of how much cash you can readily raise in case of an unforeseen need.

Estimating your net worth involves constructing some sort of personal balance sheet, which should very similar to the "statement of assets and liabilities" that we often hear associated with delinquent politicians and government officials. There are two key differences between this personal balance sheet and the actual balance sheet of a business or an individual's statement of assets and liabilities:
  1. We record assets and liabilities based or their current market value and not on their historical or acquisition cost
  2. Apart from financial and real assets, we also consider human capital--how much one's future earning potential is worth today
Market value vs. acquisition cost

The generally-accepted accounting practice is to record the acquisition cost of assets and just deduct an estimated deterioration in value--a practiced referred to as adjusting for depreciation. While it is often practical to use this method to record assets, at times the difference between this value and an asset's current market value--the price one can get if one sells the asset today--could be substantial. And since what we are interested in is how much money we can actually get for our assets at any given time, and not the amount we paid for the asset when we bought it (which is, in most instances, irrelevant information, if you recall one of the points in our previous post), it is more practical to use market values instead of historical costs.

One downside of using market values is that it is sometimes easier said than done. While the market value of some assets (such as cash, shares of stock, bonds, and investments in UITFs or mutual funds) are freely and publicly available, estimating the current worth of other assets like personal property (e.g., vehicles, jewelry, artwork) and real property may take a bit more effort and guesswork. The simplest way to estimate the market value of such assets is checking how much similar items are going for in the market. We can look at classifieds and publications like Buy & Sell for recent price information. If you have property in Sta. Rosa, Laguna, for example, then check how much similar properties nearby are going for per square meter, then just adjust according to the size of your own property. We can also turn to auction websites like eBay and Sulit.ph for this information.

If current market prices are difficult to come by, then you can just always resort to the acquisition cost method. If you think your asset loses a portion of its value over time due to use or natural wear and tear, then you can estimate it's current value using this formula:

Value = acquisition cost - (number of years you have used the asset / useful life of the asset)*acquisition cost
= acquisition cost [1 - (number of years you have used the asset / useful life)]


Acquisition cost / useful life = annual depreciation

If you decide to use these formulas, you have to estimate how long you can use the asset (i.e., useful life, in years) and assume that it will be worth nothing at the end of its useful life.

Of course, if you know a bit about the mathematics of finance and the time value of money, you can always use the discounted cash flow (DCF) approach, where the current worth of an asset is just equal to the present value of the future cash flows that it is able to generate.

In Part 2, we will discuss human capital--what it is and how to estimate its value--and common items that are found on a personal balance sheet.

Monday, November 14, 2011

Pop Quiz Results: A Closer Look at How We Make Decisions

The point of this exercise is to demonstrate the way we make decisions and the rules of thumb or heuristics that we employ--often subconsciously--whenever we face situations with only incomplete or imperfect information.

Nine have dared face the challenge. Let's see how these brave souls have fared.

1. A town has two schools: one large and one small. Assuming there is an equal number of boys and girls born every year in the Philippines, which school is more likely to have close to 50 percent girls and 50 percent boys born on any given day?

A. The larger
B. The smaller
C. About the same (say, within 5 percent of each other)

The obvious answer is C since, by intuition, the size of the school should not matter much, if at all. However, if we recall our college or high school statistics, the size of the sample does matter: the bigger the sample is, the more likely our estimate is closer to the actual value (more specifically, the variance of all possible estimates is inversely proportional to the sample size); therefore, the correct answer is A (6 of 9). The infuriating thing about statistics is that important relationships like this don't make a lot of sense at first glance, so are easily taken for granted by people, especially in real world situations.

2. A team of psychologists performed personality tests on 100 professionals, of which 30 were engineers and 70 were lawyers. Brief descriptions were written for each subject. The following is a sample of one of the resulting descriptions:

Juan is a 45-year-old man. He is married and has four children. He is generally conservative, careful, and ambitious. He shows no interest in political and social issues and spends most of his free time on his many hobbies, which include home carpentry, sailing, and mathematics.

What is the probability that Jack is one of the 30 engineers?

A. 10–40 percent
B. 40–60 percent
C. 60–80 percent
D. 80–100 percent

Since 30 out of the 100 professionals that were interviewed are engineers, the probability that Jack is an engineer is 30%, so the correct answer is A (5 of 9). The reason why some people would think of a higher probability is that they associate the characteristics mentioned in the given description--like being interested in carpentry, sailing, and mathematics--to being an engineer, even if no actual data supports such an association. This rule of thumb is called the representativeness heuristic.

3a. How many dates did you have last month?

A. 1–3
B. 3–5
C. 0

3b. On a scale of 1 to 5, how happy are you these days (5 being the happiest)?

A. 1
B. 2
C. 3
D. 4
E. 5

It should be obvious that this one doesn't have a correct answer; the point of these two questions is to demonstrate that the first question can easily influence our answer to the next. From the answers of our respondents, we see that a higher number of dates in 3a would likely lead to greater happiness in 3b, and vice versa. However, if the order of the questions were reversed, it's highly likely that responses to the happiness question would have little correlation with the dating question. This demonstrates that how questions or alternatives are presented do affect decision making, even if decision theory tells us that they should not. This phenomenon is referred to as the framing effect.

4. Imagine that you decided to see a play and you paid 500 pesos for the admission price of one ticket. As you enter the theater, you discover that you have lost the ticket. The theater keeps no record of ticket purchasers, so the ticket cannot be recovered. Would you pay 500 pesos for another ticket to the play?

A. Yes
B. No

This question demonstrates two important concepts in decision making. The first is the concept of the sunk cost: that is, past, irrecoverable costs should be irrelevant in decision making. In this situation, the lost ticket would definitely qualify as a sunk cost, so if one really wants to watch the play, then one should not hesitate to pay for another ticket, an alternative which most of our respondents have chosen (6 of 9). However, to a great degree the answer to the question is a matter of personal choice, so there really isn't a correct answer to this question.

We can also use the question to illustrate how framing works. Experiments show that most people would actually choose not to buy a ticket, an indication that people do consider sunk costs in making decisions. If you answered "no" to the question, then consider this analogous scenario:

Imagine that you decide to see a play and you will pay 500 pesos for the admission price of one ticket at the door. As you enter the theater, you discover that you have lost a 500 peso bill. Would you still pay 500 peso for a ticket to the play?

Experiments show that people who answer "no" to the first question would often answer "yes" to the second; this does not make a lot of sense since the two situations are the same and represent the same economic loss of 500 pesos, albeit expressed or framed differently. It's like agreeing to buy a glass that's half-full for a certain price, then refusing to buy a half-empty glass for the same price.

5a. Choose between getting 9,000 pesos for sure or a 90 percent chance of getting 10,000 pesos.

A. Getting 9,000
B. 90 percent chance of getting 10,000

5b. Choose between losing 9,000 for sure or a 90 percent chance of losing 10,000.

A. Losing 9,000
B. 90 percent chance of losing 10,000

Again, these two questions have no definite correct answer, but are used to demonstrate that people often weigh gains and losses differently. Actual experimental data (I have actually always asked my finance students to answer these two questions) show that respondents tend to answer A and then B (7 out of 9 of you did :)); this result is anomalous since choosing A in the first question is a sign of risk aversion while choosing B in the second question is indicative of risk-seeking behavior. In other words, we can't simply classify decision makers as being "risk averse" or "risk seeking," as traditional decision theory tells us, since individuals can easily avoid risk in a particular situation, then seek it in another, or vice versa. This phenomenon is referred to as prospect theory.

These questions come from a Vanity Fair feature on Nobel Laureate Daniel Kahneman who, together with Amos Tversky, paved the way for behavioral finance/economics/decision making into becoming popular fields of academic research and pretty much debunked the myth of the rational decision maker and the economic theories that are based on this assumption.

Next week, we'll talk more about the heuristics and anomalies that we talked about in this post, and a few others that we have not covered.

It's not enough to just know how people should make decisions: it pays to also know how people actually do.

Thursday, November 10, 2011

Pop Quiz

1. A town has two schools: one large and one small. Assuming there is an equal number of boys and girls born every year in the Philippines, which school is more likely to have close to 50 percent girls and 50 percent boys born on any given day?

A. The larger
B. The smaller
C. About the same (say, within 5 percent of each other)

2. A team of psychologists performed personality tests on 100 professionals, of which 30 were engineers and 70 were lawyers. Brief descriptions were written for each subject. The following is a sample of one of the resulting descriptions:

Juan is a 45-year-old man. He is married and has four children. He is generally conservative, careful, and ambitious. He shows no interest in political and social issues and spends most of his free time on his many hobbies, which include home carpentry, sailing, and mathematics.

What is the probability that Jack is one of the 30 engineers?

A. 10–40 percent
B. 40–60 percent
C. 60–80 percent
D. 80–100 percent

3a. How many dates did you have last month?

A. 1–3
B. 3–5
C. 0

3b. On a scale of 1 to 5, how happy are you these days (5 being the happiest)?

A. 1
B. 2
C. 3
D. 4
E. 5

4. Imagine that you decided to see a play and you paid 500 pesos for the admission price of one ticket. As you enter the theater, you discover that you have lost the ticket. The theater keeps no record of ticket purchasers, so the ticket cannot be recovered. Would you pay 500 pesos for another ticket to the play?

A. Yes
B. No

5a. Choose between getting 9,000 pesos for sure or a 90 percent chance of getting 10,000 pesos.

A. Getting 9,000
B. 90 percent chance of getting 10,000

5b. Choose between losing 9,000 for sure or a 90 percent chance of losing 10,000.

A. Losing 9,000
B. 90 percent chance of losing 10,000

*** END OF QUIZ ***

Please post your answers on the comments sections below. On Monday I'll tell you what this is all about, so finished or not finished, pass your papers! If you already know what this is, please don't spoil it for the others--thanks in advance--and just state your answers on the comments section.

Monday, November 7, 2011

My Take on the Best Statistics Question Ever

A difficulty that students often face is that exam questions like this may be interpreted a number of ways, with each interpretation leading to a distinctly different answer. In this post, I offer two such interpretations.

The first leads to the same answer as one of our readers: "0% the correct answer is not among the choices." Here we assume that the question that needs a correct answer is "what is the chance you will be correct," and that you would only be "correct" if the probability of picking your answer is the same as the value of your chosen answer.

Say, you randomly pick "25%". Since two out of the four choices represent "25%", then the probability of randomly picking it is 50% (assuming equal likelihood). And since your answer--25%--is not the same as the probability of picking your answer--50%--then you will have been incorrect.

Using the same logic, it's easy to see how picking the other two available choices, 50% and 60%, would also be incorrect. This means that the chance that you will be correct is zero--there is no chance that you will be right!

Of course, if you read the problem differently, you should arrive at a different answer. For example, if we assume that "being correct" refers to some other arbitrary question, that the choices pertain to that question and not to the chance that your answer will be correct, and that one of the given choices is the correct answer, then we'll arrive at an altogether different solution.

We are still interested in the probability of randomly picking a correct answer, but this time we do not limit this probability to the given choices. We could go through equations and basic laws of probability to solve the problem, and in the end we'll most probably arrive at the correct solution, but there is a simple way of reasoning out the correct solution instead. 

First we recognize that there are only three possible answers to the problem: 25%, 50%, and 60%. If we assume that the three are equally likely to be the correct answer, then the probability that each will be correct is 1/3. Or,
  • If C = the correct answer, where C = 25%, 50%, or 60%. Assuming these choices are equally likely to be correct, then the probability of C, P(C = 25%) = P(C = 50%) = P(C = 60%) = 1/3.

Since the probabilities are all the same, then the actual choice we pick does not matter: whatever we choose, the probability that it will be the correct answer is 1/3.

Can you think of another approach to solving the problem? Feel free to share your thoughts in the comments section below.

Thursday, November 3, 2011

Monday, October 31, 2011

PLDT-Digitel Deal Finally Gets NTC Approval

IN THE NEWS from Business World Online

After seven months and three postponements, the much talked about PLDT-Digitel deal, which first broke out on Investor Juan, finally gets the approval of the National Telecommunications Commission. The deal provides the PLDT-Digitel union with a dominant 70% share of the market and leaves Globe at farther second, eliciting criticisms from various sectors who fear that the industry might revert to a monopoly.

The approval comes with the following conditions:

  1. That PLDT-Digitel offer Sun Cellular's unlimited text and call services permanently.
  2. That PLDT and Digitel "continue providing high quality service to their respective subscribers."
  3. That PLDT divest 10 megahertz of 3G frequencies held by Smart. Said frequencies will be auctioned off and PLDT will not be allowed to bid.
All three parties involved--PLDT, Digitel, and Globe--have reportedly expressed their acceptance of the conditions laid out by the NTC.

If we take a closer look at these conditions, it seems that the only one that matters to Globe would be the last one, that the most important (or perhaps, only) reason why it tried to block the deal was that it wanted those valuable 3G frequencies as a form of concession. I mean, who is the NTC kidding? The first two conditions are clearly inutile. First, I don't think NTC is in any position to dictate what any player should sell, much less sell permanently. And even if by the slightest chance NTC does have that power, it does not say anywhere that PLDT-Digitel cannot increase the price of these unlimited services. Second, what does "high quality service" even mean? Would Sun Cellular's services pre-merger qualify as being "high quality"? This one has so many holes, a blind man would have trouble not seeing through it.

Anyway, perhaps what's important is that everyone seems to have gotten what everyone wanted. That is, everyone except investors and consumers; what happens to them remains to be seen. Would investors finally be able to see their bet from seven months ago pay off with NTC's approval. Maybe. Would the deal really benefit consumers in the long run, as what the major players and some observers argue? We'll see.

Friday, October 28, 2011

Revisiting that Real-World Exam-Type Problem


Dear Investor Juan,

I hope that my e-mail finds you well and patient for yet another question.

I have been a little concerned with the knowledge that my insurance plan is now owned by another insurance company, Philfirst. From my point of view, it just shows how fickle insurance companies are... Because of this, I have read several articles on how to check if your insurance company is stable. 
First, they say, is to check with the insurance regulation commission, next is to check for financial ratings and financial statements,then listen for current news about the insurance company and then watch stock trends.

Most of these things are foreign to me. I don't know how to get those information or maybe what to make of it once I see it. The farthest I could go was to check that Phil first is indeed listed in the government insurance site. But what assurance can that give me (as you said) that the company would still be in business after 10 years?

I understand that this may be a decision I have to make for myself. I do not want to end up being another "CAP" victim and yet I also do not want to over worry myself for nothing. Would it be too much to ask if you give me your personal opinion about the matter i.e., what would you do if you were in my shoes?

I am not financially savvy as you may have well guessed from my emails but I just want to find a better way to know if my insurance company will still be there when my plan matures. I understand no one can guarantee an answer but isn't there a way to make a good guess, at the least?

Respectfully yours,

Dear Anonymous,

Hello again! Let's try to take a look at and think about things without having to bother with financial statements and all that boring stuff.

First, I don't think the offer (to retire your investment early) signals any trouble on the side of the new owners, as that comment of one of our readers seems to suggest: what it essentially is is the company's attempt to pare down its future obligations in an above-board manner as it tries to generate new sales from the purchase. Out of, say, thousands of policy holders, I'm pretty sure that more than a few will find the offer attractive enough to bite, especially since a lot of us still take the time value of money for granted or don't know how to apply it to situations outside the classroom. It's a strategy that is meant to boost the firm's value, and even if only a small proportion of plan holders accept the offer, it's a strategy that will have worked. In fact, since the offer actually decreases the risk that the firm will not be able to meet its future obligations, it actually works in favor of those who do not accept it.

Second, you would have to form an opinion about the new owners, namely Philfirst and STI. STI is more familiar to most of us: it has a solid business model which generates a lot of cash, although admittedly the computer and nursing education businesses are not as glittery as they once were. Philfirst, I'm not very familiar with, and less so the firm's controlling figure, Mr. Eusebio H. Tanco. The information on the group's website, though--assuming everything is true--should be able to allay some of your concerns. The group is supposedly awash in cash, and a big part of it is in a trust that no errant manager could be able to put his or her hands on. All this means that in terms of capacity to meet future obligations, Philplans seems to have enough to erase (at least some of) your worries.

Finally, I think it's unlikely that Philplans will be another CAP. First, while like CAP, Philplans is also in the pre-need educational plan business, unlike CAP (as far as I know), it's also into life insurance and HMOs. And unlike pre-need educational plans, where policy holders are certain to collect at a particular future date, risk is better spread in the life insurance and HMO businesses, which makes them more lucrative and less risky to both the insurer and policyholders. So even if, for whatever reason, Philplan's pre-need educational business tanks, life and HMO should be able to generate enough business to stem the bleeding of the company as a whole. Essentially, being diversified into revenue streams or businesses that are not perfectly correlated lessens the risk exposure of Philplans which customers would also benefit from.

Well, I guess that's the best I can do short of actually performing due diligence. Just to make myself clear, my personal opinion is that you reject the offer and stick with your plan.

Good luck, and I hope to hear from you again.

Tuesday, October 25, 2011

3 Ways Cha-Ching Can Help You and Your Kids Become More Financially Literate

How I wish we also had this when we were growing up...

Cha-Ching is a new series on Cartoon Network that aims to teach kids basic financial concepts and money management skills. The stories revolve around six kids who form a band called--yes, you guessed it--"Cha-Ching" and how the group deals with real-world financial situations. I haven't seen any episode yet, but I've spent some time on the accompanying website, which I think would probably have much more to offer than the show itself. In fact, the website alone offers several fun ways you and your kids could learn more about earning, saving, and spending money.

1. Through song

Perhaps the reason why a lot of young people (like my students) are not very interested in finance is that it could become quite boring real fast (as some of you readers already probably know :| ). The creators of Cha-Ching decided that the best way to teach the young and old alike the intricacies of finance is by adding catchy tunes to otherwise bland and boring verses and turn them into colorful music videos. Take a look at this one entitled "Entrepreneur," for example.

At the very least, we'll learn how to pronounce the word correctly. ;)

2. With games

Perhaps the best way to make the most out of Cha-Ching is to play the games featured on the website. "Cha-Ching Saver" is a cross between a Super Mario World-like platformer and a typical RPG: you earn coins by playing platform mini-games and then decide how to use your coins on the world map. The objective is to earn as many coins as you can and be featured on the Leaderboard for bragging rights.

The second game is called "Entrepreneur" where, as the name suggests, you get to form and run your own virtual business. This game is actually pretty cool since you get to see (and learn) how decisions in different management fields like marketing (see the 4P's below!) and operations (wow, inventory management for 10-year-olds!) could affect your bottom line.

3. With helpful tools

Finally, Cha-ching provides users with helpful tools like the iPhone "Pocket Money Manager" app and the "Family Budget Manager" which is a watered-down version of the Excel budget planner I featured a while back. These tools can help kids and parents alike apply some of the things they have learned from Cha-Ching to real-life situations.

All in all, Cha-Ching is a welcome development in promoting financial literacy both in children and adults. Since financial literacy is not part of the official curricula in elementary and high school, Cha-Ching stands as perhaps the most effective way to teach young people to be more mindful of how to earn, save, and spend money.

Friday, October 21, 2011

ETFs and REITs for Investors Abroad


Dear Investor Juan,

I've been following your blog for quite sometime and I really find it very informative. Just this month I started working here in Singapore and I would like to explore some investment opportunities here. I am particularly interested in ETFs and REITs and have been reading about them. However, I am having some difficulty in understanding since most of the explanations online are too "technical". I hope you can enlighten me.

Thank you.


Dear Syd,

Exchange traded funds or ETFs and real estate investment trusts or REITs are popular investment vehicles in more developed markets abroad such as Singapore, as you have mentioned, Hong Kong, and the US. They were designed to give "ordinary" investors like us an opportunity to invest more efficiently, so it's important that we learn as much about these investment instruments as we can.

I actually already discussed these topics in previous posts, but I don't mind discussing them again here briefly, and hopefully more simply.

Exchange traded funds

There are perhaps a hundred different kinds of ETFs available in the market, but the simplest are just pools of funds that are invested in either stocks or bonds, just like UITFs and mutual funds. There are two important differences between ETFs and UITFs and mutual funds, however. One is that ETFs are close-ended, meaning they have a fixed number of available shares and regulatory approval is needed before additional shares could be issued, unlike UITFs and mutual finds which are open-ended. Another difference is that ETFs are traded in stock exchanges whereas UITFs and mutual funds may only be sold back by investors to the issuing bank or financial institution; the implication is that whereas UITF and mutual fund unit/share prices only change daily, ETF prices change as they are traded, in real time.

Perhaps the most popular ETFs are index ETFs, be it stock or bond. A stock index ETF in Hong Kong, for example, would mimic the movement of Hong Kong's Hang Seng index by being invested in the component stocks of the index, much like equity UITFs and mutual funds. However, since index ETFs are not actively managed unlike comparable UITFs and mutual funds since the proportion of each stock in the fund is based on the composition of the underlying index and not determined by a professional fund manager, they are significantly cheaper; this is the main reason why we often hear investment gurus recommend index ETFs to investors. Finally, ETF investors earn as they do from stocks, from dividends and capital gains.

Real estate investment trusts

REITs are an important financial innovation in recent history. They give ordinary investors the ability to diversify into real estate-backed assets without having to shell out a huge amount of capital. Basically, a
REIT is pooled capital that is invested in income-generating real estate projects like commercial buildings or malls; investors participate by buying shares of the trust, which are also traded in stock exchanges, and also earn from dividends and capital gains.

While there also are investment funds like UITFs and mutual funds in countries like Singapore, ETFs and REITs often offer better and more inexpensive opportunities to diversify, so you might want to consider them first. A big portion of my capital here in Hong Kong is actually invested in a stock index ETF and a REIT, and I'm not worried a bit about these investments despite the global financial uncertainties we currently face. I'm not exactly sure how things are in Singapore, but as far as I know stocks are relatively cheap, in general, so it might be a good time to invest in a stock index ETF now; and I remember reading somewhere that the real estate market in Singapore is healthy especially compared Hong Kong's and China's, so it might be a good idea to buy some REIT shares as well (you have to do your own research about this first, of course). You may want to take a look at this previous post where I discuss specific investment alternatives in Singapore.

I hope you now have a better idea of what ETFs and REITs are, and are now hopefully confident enough to seriously consider investing in these assets. Good luck!

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