Costs have a dramatic impact on individual investor’s long-term savings outcome and only becomes apparent once the impact of fees is inspected through the correct lens. Often a visual representation rings home best as an investor is able to see the impact black on white. Over time, even small, ongoing fees can have a big impact on an investment portfolio and higher costs can significantly eat away at an investment’s growth over the long term. When viewed alongside the impact of inflation, the impact and importance of fees become even more important.
The effect of inflation should remain top of mind and investment returns (including costs) should always be above inflation.
Costs create an inevitable gap between what financial markets return and what investors earn on their investments. As illustrated in the below graph (simulated portfolio consisting of an allocation of 60% to the All Share Index and 40% allocated to the All Bond Index), you can see how fees impact an investment, especially over longer time frames – highlighting the importance for an investor to properly understand the consequences thereof. Passive investments can be a useful tool for exercising cost control but diversification remains key, as with all investments.
In summary, the above graph illustrates the following impact of fees on investment outcomes:
There are many different types of fees that can be charged on an investment. If an investor doesn’t realise just how much all the different, smaller fees add up to in total, they could end up feeling (and in some instances being) misled. Therefore, investors should check their statements as well ask how much the financial adviser is compensated in addition to the asset manager cost and operating expenses.
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It is also important to distinguish between ongoing fees (such as investment advisory fees and operating expenses) and standalone once-off fees (such as commissions and advisor’s fees). If upon review, the investor decides that the combined fees are too high, it would bode well to discuss the fee structure with their adviser or asset manager as well as obtain quotes from other financial services providers.
The Association for Savings and Investment South Africa (ASISA) introduced the effective annual cost (EAC) measure with the aim to allow investors to compare the charges incurred and the impact on investment returns when investing in different financial products. It is expressed as an annualised percentage and is usually made up of the following costs:
· Investment management costs – costs and charges for the management of all underlying investment portfolios
· Advice charges – initial and annual fees, both lump sum and recurring
· Administration charges – all charges relating to the administration of a financial product
· Other charges – all remaining charges such as termination charges, penalties, loyalty bonuses, guarantees, smoothing or risk benefits, wrap fund charges and risk benefits like waiver of premium.
As mentioned above, passive investments products could bode well as an option to reduce cost. As passive investments track an underlying index it will following the same investment trend as the underlying security or asset it tracks – so due consideration should be given with regard to what to invest in. One of the main advantages of passive investments is the lower costs (when compared to active management).
Active or passive?
In the world of investments, there is perhaps no choice more contentious than the active versus passive investment management debate. Active management does come with a heftier price tag when comparing the two by means of cost. With that being said, when used in tandem the two methods can work together in ways that deliver the best of both worlds while compensating for the downside risk of each.
At the end of the day, paying a fee for services rendered is inevitable and investors should consider just how much they are willing to pay for sound advice. The cost to invest, the investor’s time horizon, investment objectives, risk tolerance as well as the quality of advice required can be quite the balancing act and should be given due consideration. For the most part, this balancing act is aided by means of an adviser, which might come at a fee but could be very well worth it in the long haul versus an investor simply following the pack and listening to advice from friends and family (which can be a gamble). Often when investors decide to forfeit costs and rather rely on market movements is can lead to investors chasing returns and the markets, which many managers would tell you is a futile exercise.
When structuring your investment plan, it is recommended that an individual discuss their requirements with an accredited financial adviser. An adviser can help you navigate the complexities of investment decisions to achieve your financial goal.