The local stock market’s poor performance has put pressure on fund managers and financial advisers to show that they are adding value.
In years when returns are at 15% or 18%, investors don’t blink twice if fees are more than 2% per annum, but over the last five years the typical unit trust used to save for retirement only delivered about 5.4% per annum (before inflation but after fees). In such an environment, paying 2% suddenly means you are sacrificing almost 27% of your return.
While fees are always an important consideration when investing, it is particularly important when saving for retirement as the compounding effect of recurring fees can wreak havoc with the investment pot. Consider for a moment that by paying just 1% less in annual fees over a 40-year period you can increase the value of your retirement pot by roughly one third (34%).
First things first: Know what you payTo assist investors with fee comparisons, the Association for Savings and Investment South Africa (ASISA) adopted the Effective Annual Cost (EAC) Standard in 2016. The EAC is a standardised way of disclosing the various subcategories of fees related to retail savings and investment products. Where investors obtain quotes from a product provider, it will also include an EAC to allow for an easy comparison between products. The EAC includes:
The investment management fee
With the investment management fee investors should consider the total investment charge (TIC), which includes the total expense ratio (TER) as well as transaction costs. Where funds hold a significant amount of assets and don’t trade that often, transaction costs will be low (0.1% or less). The TER includes all those expenses related to managing the fund (the base fee, performance fee and VAT).
The performance fee is the fee active managers charge if they generate a return that is higher than the benchmark used for the fund. Be wary of performance fees, particularly where the base fee for a fund is already quite high. If a fund manager levies a performance fee, ask if they use a “high watermark”. This means that if the manager charged performance fees for outperformance relative to the benchmark, but experienced a period of underperformance thereafter, investors will only start paying performance fees again once the underperformance has been reversed.
The advice fee
The advice fee will depend on the financial adviser’s service model and may be negotiable.
The administration fee
Some product providers do not levy administration fees, but generally these fees will be linked to the amount invested.
Other fees include termination fees, penalties, loyalty bonuses or guarantees.
If the “other fees” seem high relative to the overall EAC, this may be cause for concern as investors may be penalised for early redemption or if changes must be made to the investment along the way.
How fees differThe total fee will depend on a range of factors, which could include
- The type of investment (a unit trust that only invests in shares will typically be more expensive than a money market fund)
- The amount invested (larger investments will usually qualify for a lower fee as a percentage of the amount invested)
- The adviser’s fee
- The platform fee (a platform is basically an online investment retailer. The platform fee is a service charge levied to administer all your investments in one place.)
For example, even if two individuals invest in the same unit trust through a retirement annuity, the fees may differ because of differences in the fee structures used by their respective advisers or differences in the way the investment platform fees are determined. A total investment charge for a unit trust retirement savings vehicle of more than 2% per annum is arguably on the expensive side, but there are various moving parts to these calculations which can have an impact on the outcome.
So, are you paying too much?This will depend on your personal circumstances, investment choices and goals. To determine if you are paying too much, consider the following questions:
- Are the fees in line with similar funds?
- If not, can the manager or adviser show that they are adding value?
- Are the fees transparent and easy-to-understand?
There are now a multitude of index-type unit trusts or exchange-traded funds (ETFs) available to save for retirement where charges are below 1% per annum, which means that investors need to have a lot of conviction in their choice of manager to be paying significantly more than 1.5% when saving for retirement.
Give due regard to fees, but rather than blindly chasing after the cheapest investment, consider fees as part of your broader financial plan and investment goals.
The information contained in this document does not constitute as advice. Should you need advice, please contact one of our friendly and capable 1Life high advice consultants.