Chief Executive Officer, what are the charges?

Highlights in this issue:
• The 1 number you need to know more than anything else when making an investment...
 
• Fees and feasability...
 
• The maths of deception... and more... 
 

From the dusty desk of Gary Booysen

Dear Investment Academy reader,

In the last few Wednesday editions of the Investment Academy, we’ve been looking at the the general markets and how they affect you. But, with generalistion, you loose the sight of the individual. Today, we're going to narrow our focus significantly and look at an issue raised by one reader that'll affect every investment decision you ever make.

What'll it cost me

With the myriad costs associated with any investment, whether it’s transfer duties, agent commission, stamp duty and administration costs of property or the associated brokerages fees, basic charges, MST, STRATE, IPL and the ever present VAT, it can be very difficult to see what the price tag on your investment is. Today, we’re going to look at an example of how all this can be solved by one simple number: The Reduction in Yield (RIY).

Gerhard Joubert is the CEO of the Life Offices’ Association (LOA). It's a trade association representing 95% of South Africa’s long-term insurance whose member companies manage assets of R1,000 billion. He explains RIY below:

“The charges that are levied against any investment or savings policy are generally a combination of the following:
• Initial fees
• Annual administration fees
• Annual management fees
• Performance fees
• Fixed rand or percentage policy fees
 
By summarising the above charges in one figure, the RIY provides financial advisors and consumers with a simple, yet accurate, way of analysing and comparing the charges of different companies and different products and helps clients choose a product that's fairly priced.”

How much difference can reduction in yields make?

Our reader asked that we compare the difference between the profits earned on an investment with and without “management fees”, which are equated to RIY (if we ignore the initial fees, admin fees, etc.)

Let's say we invest a lump sum of R10,000 into a unit trust. In column A, there are management fees of 3.5% per year, whereas in column B, there are no management fees. We plan to leave our sum of money in the investment for 20 years. Let’s assume that there’s a net gain on the unit trust of 15% per annum.

The maths goes as follows: 

Year             A                B
         (Management     (no fees)
           fees 3.5%)

2010    R 10,000.00    R 10,000.00
2011    R 11,150.00    R 11,500.00
2012    R 12,432.25    R 13,225.00
2013    R 13,861.96    R 15,208.75
2014    R 15,456.08    R 17,490.06
2015    R 17,233.53    R 20,113.57
2016    R 19,215.39    R 23,130.61
2017    R 21,425.16    R 26,600.20
2018    R 23,889.05    R 30,590.23
2019    R 26,636.29    R 35,178.76
2020    R 29,699.47    R 40,455.58
2021    R 33,114.91    R 46,523.91
2022    R 36,923.12    R 53,502.50
2023    R 41,169.28    R 61,527.88
2024    R 45,903.75    R 70,757.06
2025    R 51,182.68    R 81,370.62
2026    R 57,068.69    R 93,576.21
2027    R 63,631.59    R 107,612.64
2028    R 70,949.22    R 123,754.54
2029    R 79,108.38    R 142,317.72
2030    R 88,205.84    R 163,665.37

The table spaks for itself! With a 3.5% reduction in yield, your investment potential gains have collapsed. Once you factor in compounding over the 20 years the investment's held, your investment has grown a respectable R78,205.84. But if you remove the 3.5% management fees (RIY), you have a net profit of R153,665.37! With a charge as small as 3.5%, you could lose almost half your potential profit!

Be very careful to do the maths before entering any agreement. There are very easy ways of making the fees look very insignificant. If you consider the example above, a tiny proportion of your annual income can result in MASSIVE declines in your profit and your nest egg.

Until next time,

Happy investing!

Gary Booysen
For the Investment Academy