Recently I was asked by a client to review a Retirement Annuity which was started in early 2013. The monthly contribution is about R6000 per month. The underlying investment is in one of the companies “house” funds so no external fund manager was chosen which saves about 1% in fees. Good news – sadly that’s the last of the good news in this case.
The average portfolio return was 4.76% per annum. Not great if you consider the average fund return in the same ASISA category was about 8% over the same time period. We can’t all pick winners from the start and to be fair, this is long term money so let’s give the Fund Manager the benefit of the doubt – performance will improve. Butthen when we look a little deeper into the investment, it soon becomes apparent that this investment will forever struggle to create wealth no matter how well the fund manager does – the fees are killing returns! Despite a poor return in the fund of 4.76%, her portfolio has returned an average of -0.11% per annum.
Fees of nearly 5% are destroying all returns!
Whilst some of you reading this may firmly believe your own investments are not subject to such high fees, I can assure you we come across cases all the time where when you sit down and actually work out the total fee structure, the Total Expense ratio to the client is often well north of 3% per annum. The truth of the matter is that when it comes to investments, many people are simply unaware of what they are paying or for some bizarre reason, feel intimidated to scrutinise the costs with their advisors.
Which should you look out for?
Fees come in many shapes and forms. Some obvious and easy to find, others a little more elusive. Some companies quote monthly fees – which always look so small. For example, Is a commission fee of 0.125% per month really such a big issue? It sure is – its 1.5% per annum!
Some of the more common fees include:
Some investments through life companies include another layer of fees such as management fees and commission fees.
The impact of lower costs
A very simple example will illustrate just how dramatically fees impact your returns over time. Let’s assume you invest R2500 per month into two different investments for 20 years. The first is a Harbour Advisory Model Portfolio and the second is through a competitor of ours of which we know the fee structure. For the sake of this comparison, we will assume both underlying investments have the same gross returns before fees of 12%. The total costs in the Harbour Model inclusive of VAT are 1.56% per annum. The total costs in the other investment are 3.15%. In 20 years’ time, the Harbour Model will have grown to R2 050 000 and the competitive Fund to R1 638 000 – a 25% difference! The longer the period, the great difference – over 30 years the difference is nearly 40%.
Making your portfolio work – understand the fees “An investment in knowledge pays the best interest” – Benjamin Franklin
“An investment in knowledge pays the best interest” – Benjamin Franklin
Understanding the fees you pay is critical to understanding your investment portfolio. I am not for one moment saying the lowest fee will result in the best return. It’s part of a much bigger picture when constructing an investment portfolio that’s right for you. For example, if you are using active management in your portfolio, usually at a much higher fee than passive management, make sure your fund manager has a track record to justify the higher fee. Is your advisor charging you an upfront fee and if so why – there may be a very good reason, there may not. If your advisor is charging you an on-going fee, what are you getting for this, i.e. what is your advisors value proposition?
Every year, there is a report stating that over 90% of South African’s will retire with insufficient savings. What the report will not detail is how many of these people actually may have had sufficient savings had it not been for fees eroding their capital over 30 years. And therein lies the crux of the problem. By the time you realise your portfolio has been constructed incorrectly or with exorbitant costs, it’s too late. Costs truly are forever. Understand your fees; it’s the first step to understanding your portfolio.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)