The Money Guide: Retirement (part 2)
Why do costs matter in retirement savings?
We help you understand the costs you are paying
Every investment, including your retirement savings, has costs. Costs take away from your returns, creating a gap between the returns that investment markets deliver and what you earn on your investments.
Some costs are well disclosed and some not.
Costs that are disclosed may seem like small amounts – a low percentage such as 2% or 3%. But you should remember you don’t lose just the amount that the costs add up to, but also the growth on the amount you would have had for years into the future.
If you’re investing for a long time, as you do when investing for retirement, the effect of the costs compounds or multiplies over time, adding up to a significant amount.
Costs are forever, market returns are not, advocates of low-cost investments say.
This is because the amount you will pay in costs is mostly certain – a set percentage per month or a rand amount each month. Your investment returns, however, are not. While you can generally expect returns to grow your money, the exact returns you earn for the period for which you are invested are a lot less predictable than costs.
By paying attention to the costs you pay and trying to minimise them, you can have a more definite impact on your retirement savings – and ultimately your pension – than by chasing uncertain returns.
In a 2013 discussion document on costs in retirement funds, the National Treasury shows the effect of costs over a 40-year period. It says if you could reduce your costs from 2.5% of your savings to 0.5% annually, you would, all else being equal, retire with a benefit that is 60% greater.
According to 10X Investments, this probably understates the long-term fee impact because the National Treasury’s numbers are based on the real (after-inflation) return that investors can expect from their multi-asset or balanced portfolio with up to 75% in equities.
Understand the costs you are paying
The costs you may pay on your retirement savings include:
1. Administration fees
Your retirement fund will appoint an administrator to record contributions, investment returns and payments.
Administrators may charge a percentage of your contributions or a rand amount per member per month. A fixed rand amount is more beneficial for you if you contribute a high amount.
If your retirement fund offers a choice of underlying investments, it’s likely to do so through an investment platform or linked investment service provider. The investment platform will charge the administration fee.
2. Investment costs
Every retirement fund must invest your savings to make them grow. The investment or asset management costs are charged as a percentage of the amount you have invested – referred to as a percentage of your “assets under management”. If your fund offers you a choice of investments, each underlying unit trust fund or life assurance portfolio will have different asset management fees.
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Some funds or portfolios charge performance fees. These fees depend on the returns your investment earns – typically there is a base fee that you pay regardless of what returns you earn and a fee that applies to any returns above a certain level of return or hurdle rate. The fee may be unlimited or capped at a certain percentage of your investment.
Unit trust funds quote asset management and other fees deducted within the fund, such as bank charges, audit fees, taxes and custodian fees, as a total expense ratio (TER).
Funds also quote a total investment charge/cost (TIC), which includes all the fees in the TER and the costs of trading the shares, bonds or other securities in the fund. These costs include brokerage, security transfer tax and investor protection levies.
3. Advisory or consultancy fees
If you belong to an employer-sponsored fund, your employer may engage an employee benefits consultant to advise it and give you ongoing advice. It will also probably use an investment consultant to advise it on how the fund should invest.
As an individual joining a retirement annuity (RA) fund or preservation fund, you may choose to use a financial adviser to advise you, and you need to agree to pay your adviser an ongoing fee for his or her advice. Some advisers also charge an initial fee for the advice they give you on selecting the right product. You should be able to negotiate these fees with your adviser.
Commissions are still payable on some life assurance RAs, and these are less transparent than advice fees. Commissions are typically based on your contractual term. If you break the terms and conditions of the contract, you can be held liable for a penalty that covers the commission that would have been paid had you adhered to the terms of the contract.
These penalties are now limited to 15% of your savings for policies sold after 2009 and 30% for those sold before this date, but have in the past been as high as 40% of your savings.
4. Other costs
There are a number of other costs that may be included in the administration fee or charged separately. These include auditors’ fees, trustee remuneration, professional indemnity insurance and levies paid to the Financial Services Board.
Life assurance companies’ retirement funds may include a fee for a loyalty bonus that is paid to you if you remain invested for the term. Some life assurance RA funds charge these fees as a monthly policy fee.
Controlling the costs you pay
If you’re a member of an employer-sponsored retirement fund, there isn’t much you can do about the costs you pay other than put pressure on your trustees to focus on these and reduce them where possible and appropriate.
If you’re choosing your own RA or preservation fund, you should, however, pay attention to the costs although they can be difficult to compare.
A new standardised cost measure, known as the annual effective cost, is available for some unit trust RAs and preservation funds. It will soon be introduced for umbrella funds as well. This measure makes it possible to compare costs across different financial products.
If your retirement fund – employer sponsored or one you have chosen, such as an RA – offers a choice of underlying investments, you should consider the costs of your investment choices.
Typically, actively managed funds have higher costs. If you choose a fund with high TER and/or TIC, you should be confident that the fund will deliver a good return after both inflation and fees. You need to know the manager of the fund will stick to a tried-and-tested investment philosophy designed to deliver a certain average return over time.
If you are not confident that your chosen funds or investment portfolios can deliver good real after-fees returns, you can consider a lower-cost index-tracking fund.
Index-tracking funds or portfolios may follow an index made of the shares on a market in line with their market capitalisation – such as the JSE all-share index. Alternatively, the fund or portfolio may track a so-called smart beta index designed to harness an investment factor expected to deliver better returns than the market as a whole. For example, the factor may be to select shares with the characteristics that value managers would select.
As a retirement fund member, you may think you will get the best from your savings if you find the best-performing investment.
The Alexander Forbes Benefits Barometer 2014 found the important factors for determining your pension were whether you preserved your savings when you left a job, how much you contributed and how long you saved for. Costs were next in the list of importance.
When it comes to paying more for investments, bear in mind that research by Morningstar Investment Management South Africa found that generally over both three- and five-year periods, unit trust funds in the South African multi-asset low equity, multi-asset high equity and general equity sub-categories that ranked lowest on costs (the lowest quartile) had a higher success ratios in terms of returning more than the average for their sub-category.
Paying more for advice, investment and administration fees does not necessarily mean you will get better advice, investments or administration. A higher administration fee, for example, may mean your contributions are invested more promptly, which could result in a better outcome for you, but before you pay a higher fee, you need to understand what you will get for the additional expense.
This guide was written by the Money editorial team at Tiso Blackstar, sponsored by 10X Investments.
ABOUT 10X INVESTMENTS
The fees 10X charges on its retirement annuity are less than half the industry average – and the difference is invested on your behalf to compound over time.
Fees are a valuable tool for predicting investment performance. Keeping them low is one of four key pillars in 10X’s simple, award-winning investment strategy; the others are index tracking, a diversified portfolio and life-stage investing.
In an industry famous for big promises on a huge, confusing array of products, most of which disappoint, 10X uses a simple, proven strategy to give you the best possible chance of reaching your retirement investment goal: invest 15% of your income for 40 years in a high-growth index fund and pay fees of 1% per year or less.
Trying to pick winning stocks usually fails, which is why 10X relies on index tracking to deliver the returns of the market as a whole. We invest in a mix of shares, property, bonds and cash to maximise growth and automatically adjust portfolios as savers get closer to retirement to reduce risk.
Already got a retirement annuity? Let us do a free comparison of costs and expected outcomes. Nine out of 10 savers would be better off with 10X.