Beware of broker fees and tax implications – Dawn Ridler

If you’re an asset manager or broker, prepare to have your ego bruised and reputation tarnished. That’s because this sage advice is premised exclusively on the good of the client and in the main, if you did that, you’d be out of a job. Emphasis on ‘exclusively’, though my veteran broker keeps telling me he’s copying and pasting exactly what he’s done in growing his own portfolio and preparing for retirement. It’s a great line. I’ve never seen his historical books so I simply cannot tell whether he killed it or not. I know he didn’t crash. Setting financial objectives, very different for pre- and post-retirement, is crucial as is ring-fencing needs and preferences also different from one another. (As in non-negotiables versus wish lists.) Over the last decade or two, the biggest problem in poor performance has not just been poor asset allocation and adjustment, but unnecessarily high fees, says certified financial planner, Dawn Ridler. – Chris Bateman

Is there a recipe for asset allocation?

By Dawn Ridler* 

One of the most difficult decisions investors or their advisers need to make is how to allocate their investments to the various asset classes. In South Africa, ironically, it can be more complicated because there is more choice. ‘Asset allocation’ might sound very fancy, but if you’re in a ‘balanced’ unit trust, you’re probably doing it already. It’s the art of allocating the funds in your investment into different types of investments depending on what the objective or goal is for that investment.

Dawn Ridler

The major classes are cash, bonds, property and stocks and this is mirrored with your offshore investments. Today, commodities and crypto should be added into the mix, but there are others that you can also use, if you know what you’re doing (hedge funds, for example). It is no secret these different asset classes have different risks, with cash and bonds being the least risky, and property and stocks being riskier. The risk comes from volatility, and the potential that you can lose capital. Even novel investors probably already know this. What might not be so obvious is that once you take the investment offshore or convert it to another currency, even if you leave in ‘cash’, you add a whole new layer of risk. That risk is currency appreciation or depreciation.

The Pension Funds Act compels investors in RAs, pensions and provident funds to comply with Regulation 28, which caps the offshore exposure of the investment to 45% (this has just been increased), stocks to 75% and has minimums for cash/bonds. Ironically, living annuities that you are compelled to buy with two-thirds of your formal retirement funds, are not limited by Regulation 28 and you can invest 100% offshore (rand denominated) if you want. (This has always baffled me, surely it would be more important to ‘protect’ the pension of a retiree (which is the intention of Reg. 28) than protect the retirement investments of people decades away from retirement?

To add insult to injury, there are popular pundits out there who have jumped on this disparity in asset allocation and have been known to encourage anyone over the age of 55 to ‘retire from’ their retirement savings, eat the tax (as high as 36%) and push it 100% into offshore.

Why on earth would they do that? There are a couple of reasons:

  1. Vested interest. They have products where you can put those liberated (and heavily taxed) funds into which you are encouraged to invest and which will line their pockets with fees. To add insult to injury, they may even charge an upfront fee (as high as 3.5%).
  2. Confirmation bias/cognitive dissonance bias. It’s human nature to seek out confirmation that we have made the right decision (and ignore information that contradicts it). Some slick marketers will exploit this and make you feel warm and fuzzy about your (maybe stupid) decision (and buy their product, of course). Statistics can be clearly manipulated to reinforce this confirmation bias.

It is important to understand if your decision is being potentially driven by a bias; so, before you get sucked into sexy offshore ‘asset allocation’ talk from a broker, do the math on boring things like tax. The hole you might put in your savings by ignoring the long-term impact of the tax, just because you’ve been focused on the rosy future, most often is never recovered. You can do your own independent research at places like Retirement Savings Calculator | TaxTim SA

If you want to be able to make up your own mind and not get sucked in by hidden agendas, then what you need is a basic understanding of asset allocation and a recipe that you can follow and understand.

The first thing to wrap your head around is that pre- and post-retirement funds need to be treated quite differently because their objectives are quite different. In pre-retirement, the objective is to grow the investment by adding to it, and from asset growth (stocks; property; I’d take crypto out as it’s no yet regulated; commodities). In post-retirement, you are no longer adding to your investment but drawing an income from it. This switch from investing to income producing is, in essence, the financial definition of retirement. The biggest risk is that this income doesn’t keep up with inflation, and the capital runs out before you do.

I hate to break it to you, and I am sorry if it sounds harsh, but when you retire, it is not the time to expect your investment to make up for decades of not investing properly for retirement.

The ‘recipe’ for investing in pre-retirement should revolve around assets where you can get good growth in the long term, and that usually means more stocks than other asset classes. The emphasis is on ‘long term’. You can’t get caught up in the stress of day-to-day volatility as it will only drive you insane. You can maximise the global exposure as there are far more investment ideas offshore represented by myriad instruments. Markets will correct, and may take a year or more to come right, but if you’re a decade away from ‘retiring from’ the investment, it has time to recover and do its job: grow.

There are plenty of good, well-performing funds at low cost that you can also use for good growth and still keep within the Regulation 28 limitations. Over the last decade or two, the biggest problem in poor performance has not just been poor asset allocation and adjustment, but unnecessarily high fees. For local rand-denominated offshore funds, you can keep costs around 1.5%. You can get good local unit trusts with local assets at 1% or less. If you want to find the costs of unit trusts, look at their fund fact sheets or minimum disclosure documents (Google the name of the fund and ‘fund fact sheet’ and you should get them quickly). Personally, I won’t use funds with performance fees as they can rob you of the upside significantly. Remember, it is not the asset manager that is giving you the returns in the long term, it is the market and asset allocation. A cost of 2% doesn’t sound like much but on every R1m you invest, that is R10k in fees a year that you’re wasting and using to pay for fancy offices and perks for well-advertised or well-paid asset managers.

Post-retirement asset allocation is much trickier, and frankly don’t try and DIY unless you’re well qualified. Put bluntly, you do not have the time to make up for mistakes. My preferred method of asset allocation in post-retirement is to carve out and ring-fence the retirement pot; anything in excess of that carve-out can be treated as a legacy or bucket-list fund and the asset allocation doesn’t matter and can be done to your ‘preference’ not your ‘needs’.

That retirement pot recipe should be structured to produce an income, constantly and sustainably, for the rest of your life. There are different ways to achieve this but boring old fixed-income instruments like bonds pay a key role (but these can be mixed up with other asset classes that yield an income like dividends, pref shares or REITS.) This recipe varies significantly from region to region and will depend on what asset classes can yield in that region. Bespoke or PSP portfolios (managed by an asset manager/financial advisory team) are best suited to this approach (but need a critical mass of around R5m). Finding an asset manager that isn’t married to the stock exchange but understands the value of blending assets – and has the experience – is a challenge.

The next best thing is to use a good balanced unit trust. Margins are thinner in fixed income and balanced portfolios, so it is even more important to watch the costs. If you Google a few fund fact sheets, you will see the vast difference in these fees.

The thing with recipes is that they are put together by people who know what they are doing, and their only ulterior motive is to make something taste good. Unfortunately, when you read or listen to stuff on the media these days, you can’t make the same assumption when it comes to wealth recipes. You don’t need a recipe that looks good from far, but it is actually far from good because by the time you realise your mistake, it’s too late and the broker is long gone. With a chef, one bite of the dish and you’ll know if the recipe has worked, not so in wealth management. The problem with investments is that the ingredients keep changing all the time, the oven never stays the same temperature, and you have to change your recipe all the time. Investing is messy, economics is confusing, the world is changing but you can still protect and grow your investments if you keep your head and get help from a guide who has been wading in those swamps for a while.

Knee-jerk reactions never end well, they often end up with a bloody nose. Throughout this pandemic, people have been making rash decisions about their health and their wealth, based on advice from people with hidden agendas or ulterior motives. I call it the ‘Chicken Little’ syndrome (“Oh, oh, the sky is falling on my head, we must go and see the king.”) Sensationalism is way more popular than boring old advice. The authors get more clicks, likes and shares, all of which can be monetised. While investment advisers have to follow rules and there are consequences for bad advice (as prescribed by the FAIS Act), advice given on radio or in publications is not governed by these laws, and even the most outrageous claims can be made with no ramifications (except perhaps the occasional Twitter suspension). There is no shortcut to wealth. Arm yourself with knowledge, ask questions and get used to the hard truth that saving and building for retirement takes decades.

  • Johannesburg-based intermediary Dawn Ridler, MBA, BSc and CFP ® is founder of Kerenga.

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