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Dawn Ridler is an investment expert based in Johannesburg. Unlike many intermediaries you will encounter when trying to buy life insurance or plough savings into a fund, Dawn is not afraid to speak her mind about the “big boys” in the financial services industry. She cuts through the smoke and mirrors, to highlight tips and traps, using her extensive knowledge of the animal and plant kingdoms to provide useful analogies that shed light on the best ways to manage personal finances. In this hard-hitting column, she reminds us why placing your trust, and hard-earned savings, in investment products on offer from South African life assurers is a mug’s game. I’ve learnt the hard way, seeing my investments worth less than the sum of contributions – let alone any allowance for inflation or investment returns – as they mature. Dawn reminds us here that it’s the big fees that are the real killer, and this is why the world’s smart investors are turning their backs on greedy financial services providers. – Jackie Cameron
The good, bad and ugly truth about investment fees
By Dawn Ridler*
The West has been way ahead of us when it comes to chopping away at excess fees in investments. It was the disenchantment with these fees that lead to the birth and explosion of the ETF (passive) investment market led by the likes of Vanguard. Passive funds and ETFs (Exchange Traded Funds) have managed to cut fees by getting computers to all the work for them (instead of employing expensive asset managers).
This has gone one step further and seen the birth of robo-advisors – really just a questionnaire driven program that will come up with a recommendation in that Financial Institutions funds (i.e., rarely ‘independent”). The move toward very low fees came out of the very low growth environment after the Great Recession, where a 1% charge on a 20% return would be acceptable, but not when the return is 2%.
Although returns have certainly come back substantially in the US, closer to home we have seen a low to no growth environment for 5 years and, in many cases, the only movement one has seen in one’s portfolio is the nibbling away at your investments by fees from all over the place.
Throwing out all fees and finding the absolute lowest fee isn’t the answer either. You need to use the right tool for the right fee “pest.” Just like pests that devastate your veggie or flower garden, you can’t get out the big guns because you’ll kill every insect, fungus or other pest in sight, including honey bees, pollinators, ladybirds (that eat aphids) or root fungi that increase absorption.
Even the most dedicated planet-friendly gardener like me has her limits tested by the complete devastation caused overnight by the amaryllis worm and their voracious appetite. (The only effective, non-Armageddon/nasty chemical way to get rid of them is to pick them off and squash them, or squash them inside the leaf. A sickening, messy job guaranteed to put you off your breakfast).
If you want a targeted approach to reducing fees, unpack them on your statement and understand the good from the bad and ugly. The biggest no-no (IMHO) is ‘upfront’ fees or commission (and careful, you may even find these on ETF platforms in SA Inc.) The most common of these is upfront commission paid to insurance brokers for investments on insurance platforms. Good luck removing these once you’ve signed the policy though, if you try and stop it or withdraw from it before 5 years are up, you get that nasty ‘early termination penalty.’
On policies older than 2007 you’ll have that nasty little parasite forever – and it’s usually 30% of the market value of the investment. They all have different names for this penalty – but a rose by any other name is still chowed to death by the same bugs. When queried, the usual answer is that it is for ‘future fees’. What future fees you might ask – me and my money are out of your life! These are the future fees the insurance company choose to pay the broker on day one and the alimony you have to pay for divorcing them.
Read also: Do you REALLY need a financial advisor?
I have one simple rule, never place investments on a life insurance platform. Because you pay this commission forever, and their other fees are decidedly bloated, the ‘effective annual cost’ (most of the fees added up – performance fees may not be added) can be as high as 6%.
With the growing popularity of LISP (Linked Investment Service Provider) brokers are still trying to get their upfront chunk of commission and so may also charge an upfront fee – as much as 3.5% and still can charge an ongoing fee of 0.5% (or 1.5% if there is no upfront fee).
The argument you get from brokers about charging an upfront fee is that almost all of the work is done at the beginning of the investment, and they don’t trust the client to renege on the 1% annual fee once it has been implemented. All of us have had that happen at some stage in our careers, usually when we ignore our gut-feel about the client’s perception of the value brought by a professional.
If you have read and researched this topic, you will see that some pundits recommend paying the upfront fee only, and no ongoing fee. One can see the logic in this, 1% per annum over your lifetime is going to come to way more than the 3.5% you pay upfront. The problem is that this effectively becomes a 3-year motor plan, and the advice dries up thereafter because the advisor has no financial incentive to keep giving you advice for ‘nothing’.
One popular fee-saving recommendation is to pay for a ‘fee for plan’, which sounds very reasonable. “You write me a plan, I will pay you for it, then I will implement on my own and save all those advisory fees”. I personally don’t like or use this option for a very simple reason – that plan is perfectly correct for right now – the service on the car was thorough and the car is in tip top shape.
In time, as short as 6 months later, things change that could never have been anticipated and you may not be aware of it until it is too late – or it costs you a fortune to correct. Paying a reasonable annual fee to your advisor keeps your motor plan in place, and an advisor on call to tweak your plan and keep it on track.
Let’s put that 1% per annum fee in perspective. It might look enormous on your statement but here is today on the JSE, showing yesterday’s market movement. Just one day’s movement in the indices – so if you’re in an ETF, that is the fall (in this case) you’ll see in just one day – right up to -2.49% in resources.
Sure, this may bounce back tomorrow, or next week – or it might not. Look at the chart for REITs (Real Estate Investment Trust) below:
If a chunk of your investment had been ‘parked’ in REITs 5 years ago you’d be pretty sad today with it coming close to half its value.
Advisory fees are only one of the fees you need to keep an eye on. The asset manager fees can be several orders of magnitude bigger. In an ETF, the fees can be a little opaque and different to what you might get in a unit trust. Upfront fees can be charged, so fees on exit from the ETF are usually charged.
On average, here in SA Inc, those fees range from 0.5% to 1%. Unit trust fees range from about .6% right up to 2.8%. Then there are platform/administration fees which run in the 0.3% to 0.5% range, and if you have a pension fund or endowment, add another 0.3% or so. If you want to keep costs under control without compromising on the quality of the funds or advice you’re getting, try and keep the cost of your flexible investments below 1.5% (add 0.3% if it is a retirement fund – no getting around that one), and zero upfront fees or costs.
- Johannesburg intermediary Dawn Ridler, MBA, BSc and CFP ® is founder of Kerenga.
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