Brenthurst Wealth

The ABCs of investment fees

Brenthurst outlines the relationship between financial advice and investment expertise and the fees you pay.

Published on:

19 Jun 2023, 3:00 am

*This content is brought to you by Brenthurst Wealth

By Renee Eagar *

As financial advisors to many sophisticated clients, when we are second-guessed by clients often questioning the role advisors play in managing their portfolios. I accept this as simply part of the role, especially because hindsight is always 20/20 – so it is easy to point out alternative options that might have been chosen.

At the end of the day, my role is to suggest financial planning options based on what I know about my clients' circumstances, their goals and risk profile. They come to me for that knowledge and guidance, but also because I can introduce them to the right investment options, products and various planning tools to suit their needs and lifetime objectives.

It's easy enough to directly buy unit trusts and retirement annuities, or stocks and ETFs, but do you necessarily understand whether that will help you reach your financial goals and the intricacies of each investment option profile and what are the risks involved and more importantly how the underlying investments are invested.

As a Certified Financial Planner®, my training has equipped me with the necessary knowledge and tools to help my clients make the best decisions. I've also been trained to rely on the expertise of the highly skilled managers and platform providers of the investment funds I use to serve my clients' best interests. Their expertise lies in creating funds/ products that offer a mix of diversification, growth, and defence so that your capital grows over the long term without placing it at unnecessary risk.

I'm grateful for their consistent expertise and input because it's then easier for me to present my clients with the best possible investment options from all aspects namely investment, tax and estate planning.

That expertise does, however, come with a price tag, like everything in life…

Allow me to quickly outline the relationship between financial advice and investment expertise and the fees you pay. Taken together, these fees are referred to as the total expense ratio, which is shown as a percentage of your total portfolio being managed.

When you see the word total expense ratio and now you will understand that it consists of mainly 3 fees: (some detail on these fees is explained below)

Advisor
Fund Management (the investment fund manager who manages the unit trust, ETF etc.)
Platform (the company you are paying for the product you invest in)

Read also: Stick to the basics when uncertainty strikes

Advisor fees

Let me start by explaining the fees that you can expect to pay to your financial advisor. These are calculated as a small percentage of a client's portfolio; this fee is usually negotiated upfront and is levied from your investment monthly taking the market value of your investment into account once per month.

Fees are hard to pay but put in another way one might feel comfortable doing simple DIY repairs around your home, but would you tackle a major renovation yourself unless you had the necessary skills and tools? Hopefully, you won't because you could cause more damage if something goes wrong. The same applies to your financial circumstances.

The sensible choice is always to get in an expert, even if there is a price to pay. In the long run, you'll always be better off for making the right decision.

For instance, at present many South Africans are looking to money market accounts because of the volatility in equity markets and the high yield interest the current cycle is offering. A move into more defensive assets seems sensible enough when world markets are so volatile until you look at the complete picture.

At a time that inflation is well above 6%, the 7/8% return offered by money market funds is quickly eaten up by taxes on interest, which could be as high as 30% – 40% for high net-worth individuals. So, the net return in a situation like this would be closer to 4% or 4.5%, which is clearly well below inflation – so you are losing buying power quite quickly over time.

This is one of many examples of the value that advisors can bring to your long-term financial planning, although we play a far more important role. Research by US mutual fund giant Vanguard a few years back calculated that advisors could add as much as 3% of value to clients' returns over time.

What might surprise you is where the most value was added. According to the research, up to half of that 3% value comes from helping clients to stay invested even through the toughest times. I'm sure I don't need to remind you that the best returns are made by staying invested for the long term and that over 20 and more years, equities always come up trumps.

For this peace of mind, your advisor will charge you a fraction of the value of your portfolio. This fee, as well as the others I will discuss next, are deducted from your investment account so there is no impact on your pocket or cash flow.

Investment manager fees

This is usually the larger of the fees applied to your investment portfolio and is also calculated as a percentage of your investment funds. Fees can vary from 0.10% to more than 2% of assets being managed. These fees are included in the daily price of the investment fund, so if a fund reports a performance of 8% then it will be nett of the fund manager fee involved as an example.

The percentage levied depends on a few factors. For instance, a more conservative fund will charge lower fees than an aggressive, and an actively managed fund charges more than a passive fund. A good combination of both always works well.

In some cases, the manager might also charge a performance fee for producing returns higher than a set percentage, and specialist managers like hedge funds often charge higher fees than traditional funds.

Are these fees justified? In many cases, they are if your investments have continued to show growth over the long term and if your fund manager manages to get you good outperformance of a realistic benchmark of the market should be rewarded.

Read also: How to maximise TFSA contributions

Platform fees

The lowest of the investment fees you should expect is the product fee that is deducted from your investment every month. This fee can range from 0.10% up to 0.5%, depending on the platform used to make and manage your investments.

In addition to giving you access to investment products, the platform also manages administration like buying and selling investments, as well as important reporting tools.

Without access to these products and administrative capabilities, you wouldn't be able to manage your investments from a legislative, monitoring/tracking or tax reporting point of view.

The bottom line is that these fees are unavoidable if you wish to give yourself the best chance of retiring comfortably. Yes, you can try to manage your own funds, but this is not advised unless you have the skills and expertise to do so.

The good news is they are not always fixed fees, and you might have some room for negotiation on certain of the fees. Bulking your investments on one platform for example will bring down your platform fee instead of having investments placed sporadically. Paying lower fees will mean you end up with a bigger retirement pool of savings, so one needs to be able to ask the right questions and make an informed decision.