If compounding investment returns could be considered the Eighth Wonder of the World, then compounding investment costs can be similarly dramatic: for instance, just a 2% annual increase in return could triple your money over 50 years.
The US Securities and Exchange Commission has noted that on a
$100 000 portfolio, over 20 years a 1% annual management fee will reduce the value by nearly $30 000.
Clearly, then, costs are a vital factor in investment returns and one you need to discuss closely with your advisors. To do so, you need to understand more, and fortunately the Association for Savings and Investment South Africa (ASISA) has just released new standardised disclosure tools recognising the need to align costs more closely with TCF (treating customers fairly) regulation:
Total expense ratio (TER) determines how much of a financial product’s underlying assets are relinquished as payment for services rendered in the process of administration, and includes (though not limited to): fixed and performance-based management fees, regardless of the make-up and retention of any portion of the fee by the provider; administration costs; custody fees; trustee fees; audit fees; bank charges; taxes; net negative interest charges where net interest from trust accounts is negative for a month due to, for example, large overdrafts; expenses underlying multi-tier financial products; and all costs in relation to scrip-lending.
Transaction costs (TC) are a measure that can be used to determine the costs incurred in buying and selling the underlying assets of a financial product. These include brokerage; VAT; securities transfer tax (STT); investor protection levy; STRATE contract fees; FX; and bond spread costs.
Add to this fees you pay for advice, and the costs certainly can mount.
Needless to say, all of this becomes quite complex, but it provides a solid foundation for demystifying a plethora of costs, and a base for comparison. It is also a tool for your advisor in assessing appropriate solutions for you.
WHAT DOES THIS MEAN
- Ensure expenses are fully disclosed in supporting literature, documents, and by your advisor. Regulated products require extensive disclosures and transparency.
- Understand the expenses and ratios and what is included or excluded.
- Compare the expenses between the investment products. Be aware that whilst performance fees can align the interests of the investor and investment manager, these are variable and can use very different benchmarks. Do not end up paying for past performance.
- When reviewing investment returns, identify if these are before or after advisors’ fees. Usually it’s before.
There is no such thing as a ‘high’ or ‘low’ total expense ratios (TERs) or transaction costs (TC): these are relative to your investment returns and the value advisors bring. The question you should concentrate on is, are you getting value? Such decisions have become easier to make as transparency and knowledge continue to improve.
This means we get to ask better questions of our investment and financial advisors, and can take better investment decisions.
And as always in life, cheaper is not necessarily better. Look for value, quality and consistency.
Author: Mike Lledo CA(SA) is New Business Initiative at Citadel Wealth Management