Your investments should, one day in the future, ensure you can achieve your financial goals. Unless investment fees eat into your returns and leave you with less than you need!
Investment fees are a cost every investor pays
Investment fees are the fees you pay to an investment manager, for example Allan Gray or Momentum Investments, to manage your investments, similar to paying bank charges for your bank accounts.
How investment fees affect your investment returns
The more you pay in fees, the lower your investment return and the lower the total value of your investment. For example, if you invest R100 000 and earn a return of 6% and pay no fees, your investment will grow to R430 000 in 25 years. However, if you pay 2% each year in investment fees, you will only have R260 000 after 25 years.
Investment fees are charged at a percentage of an investment amount. For example, a fee of 1% will be 1% of your investment amount (your balance in your investment account on a particular day or days). These percentages are annual, unless otherwise specified. Investment fees are deducted from your investment account, and effectively reduce your investment returns. If your investment of R5 000 earns a one-year return of 7% (R350) and your fees are 1% (+R53), your net investment return in rands is R297. This makes your R5 000 investment at the start of the year worth R5 297 at the end of year.
Different investment products will have different fees. For example, actively managed funds, where an investment manager analyses different shares and decides when, where and how much to invest based on their research, have higher fees than passively managed funds. Passively managed funds are invested according to predetermined factors, such as shares in an index on a stock exchange.
Investment fees explained
Registered South African financial services providers, including investment managers, have to disclose all fees. Investment managers will also work out three calculations for you so you can get a clearer picture of what fees you are paying and how they affect your investment.
Total expense ratio (TER): This is the cost of investing, for example what your investment manager pays to invest money (buy and sell investments) in a fund. These costs form part of your investment fee, but not all the costs your investment incurs are included.
Total investment charge (TIC): This is the total cost of your investment, excluding charges such as advice fees. It is a useful measure to compare fees across similar investments.
Effective annual cost (EAC): This is all the costs your investment incurs over a specified time period, including advice fees. It is expressed as a percentage, for example 2%. You can use this figure to work out how your costs affect your returns and total investment value.
You can find your effective annual cost, as well as the TER and TIC on your statements. You can also use online portals to check fees, and find them on fund fact sheets, which are available on the investment company’s websites.
When you compare investment fees, make sure you compare like with like. For example, compare fees for money market investments with other money market investments and not equity investments, because different kinds of investments have different costs. Money market funds have annual fees of around 0.5%, whereas equity funds can have fees of over 1%, sometimes higher.
Top tip: A small difference in fees can be a big difference in total returns. On big investment amounts, even a 0.01% difference in fees can add up to a substantial amount. Take this into account when you compare fees.
Consider investment fees and other factors when making an investment decision.
Lower fees should mean higher returns, and in some cases they do. But not always.
We looked at three equity funds - two unit trust funds (active investments) and an exchange traded fund (passive investment) and found:
The passive fund with the lowest fees of the three funds (0.74% compared to 1.18% and 2.12%) had the highest return. R20 000 invested in this fund for five years would grow to around R29 500.
But, the fund with the highest costs (2.12%) did not have the lowest return. An investment of R20 000 in this fund for five years would grow to around R28 000, compared to around R27 000 in the fund with lower annual fees of 1.18%.
Fees should be a factor when deciding where to invest, but not the only one. Other factors to take into consideration when investing include:
- How quickly you can access your money if you need to
- If there are any penalties or costs for early withdrawals
- Your investment goals, which affect how, when and where you invest
- The service your investment manager offers
- The investment returns your fund delivers. If the return is much higher for one fund, even if the fees are higher you may still enjoy higher growth overall.
Your financial adviser can help with these considerations and also help you understand and compare investment fees.
Other costs your investment incurs
In addition to investment fees, your investment may also incur advice fees and platform fees.
Advice fees are the fees paid to your financial adviser for their services. They can be hourly rates or commission.
Platform fees are the fees incurred for using a platform, such as Easy Equities, Sygnia and online trading platforms from banks.
Consult a financial adviser or consultant from your investment provider to help you work through the fees so you know how they can affect your investment. And remember to take other factors into consideration when you invest!