How much does the privilege of investment advice and active management really cost you? Some investors may even know the TER (total expense ratio) of an investment, expressed as a percentage.
For example, if you invest R1 million in a unit trust for 20 years at an annualised return of 10 percent, and the TER is 1 percent, the return would be just over R5.5 million. At a TER of 2 percent, the return is less than R4.5 million.
A TER of 2 or 4 percent doesn’t sound unreasonable, particularly since these fees are quietly slipping away in small amounts each month, and few investors realise the impact, as returns are quoted after the deduction of fees, explains Dr Koos du Toit, chief executive officer of P3 Investment Group.
He says it sounds very different if the TER is expressed in hard, cold rand terms.
For example, if you invest R1 million in a unit trust for 20 years at an annualised return of 10 percent, and the TER is 1 percent, the return would be just over R5.5 million. At a TER of 2 percent, the return is less than R4.5 million.
If the TER goes up to 3 percent, the return drops another million to around R3.6 million, while at a TER of 4 percent, the return is not even R3 million.
It means, effectively, that if you are paying a TER of 2 percent, the impact of the fees charged over 20 years cost you a whopping R1 million, while a TER of 3 percent costs you R2 million and a TER of 4 percent, a heart-stopping R2.5 million, explains Du Toit.
But surely it is worth paying because you are receiving sound advice and active management, which will ensure outstanding performance of your investment?
Unfortunately, recent studies have indicated that, on balance, some 75 to 80 percent of all active managers of South African unit trusts fail to beat the common index benchmark, i.e. the average performance.
In fact, passively managed products, which simply track an index instead of trying to outperform it, are producing superior returns, and are also significantly cheaper, notes Du Toit.
So, for prudent, risk-averse investors, it would make sense to invest passively, simply tracking an index and avoiding the significant risk of a return below the index benchmark as delivered by 75 to 80 percent of active managers, rather than hoping for the slim chance (20 to 25 percent) of getting an above average return through active management, which involves fees that decimate the return.
“It is also unfortunate that the ‘sound advice’ investors pay so dearly for creates the impression that the choice is simply between active investment, with the fees or passive investment, with lower fees.”
It is advice that costs investors dearly, because it does not allow them to consider a tried-and-tested investment alternative that involves no advice and no fees, and - not surprisingly - returns that reflect the absence of both, he points out.
This alternative is buy-to-let property investment. Let's say that instead of investing R1 million in a unit trust or retirement annuity, you buy a townhouse in a good area with strong rental demand and good prospects for future capital growth, rent it out to a thoroughly-screened and vetted tenant and maintain the property over time.
This alternative is buy-to-let property investment. Let's say that instead of investing R1 million in a unit trust or retirement annuity, you buy a townhouse in a good area with strong rental demand and good prospects for future capital growth, rent it out to a thoroughly-screened and vetted tenant and maintain the property over time.
You would immediately start receiving a monthly rental income of R8 000 from the property, and this passive income will increase each year in line with the amount stipulated in the lease, generally 10 percent, or at least in line with inflation.
But, in addition to this ongoing passive inflation-hedged income received every month, you will also be earning capital appreciation on the value of the property.
At a 10 percent capital growth per annum, the property will be worth more than R6 million in 20 years time.
The equivalent of the rental of a townhouse (R8 000 in today’s value of money) is probably not sufficient income for a comfortable retirement.
Most ordinary salary-earning investors would be looking at closer to the equivalent of the rental of four townhouses (R8 000 x 4) or R32 000 a month in today’s value of money, to be financially independent.
Through the tried-and-tested buy-to-let investment alternative, smart investors can create this retirement income by splitting their R1 million investment into four deposits of R250 000 on each of four R1 million townhouses, and applying ‘gearing’ in the form of a home loan, to acquire four townhouses to rent out.
In this case, some of the monthly rental income of R32 000 (R8 000 x 4) will be used to repay the bonds, as well as the other property expenses, but in 20 years' time, when the bonds are settled, the investor will own a small but highly profitable portfolio of properties, generating a monthly passive income equivalent to the rental of four townhouses, which is equivalent to R32 000 in today’s value of money.
However, in addition, the four properties will also have generated capital growth over the 20 year period, also leaving the investor with a small property portfolio worth R24 million (R6 million x 4), at an assumed 10 percent capital growth.
Comparing this with an investment of R1 million in a unit trust for 20 years at an annualised return of 10 percent and a TER of 4 percent, which would yield not even R3 million, consider carefully the cost of ‘sound advice’ and active management on your retirement future.
Take time to consider an investment alternative that eliminates the exorbitant cost of advice and active management, ensuring every cent you invest is working for you, and only for you, he adds.
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