Understanding the exact nature and magnitude of the fees levied on your investments has always been critical in evaluating the value you derive from these products and the portion of your returns you are truly able to benefit from.
Over the years, the financial services industry has attracted much criticism with regards to the excessive levels and complicated structures of product fees. When added to the intrinsically complicated nature of the products themselves, it is understandable that some investors are left overwhelmed and frustrated.
However, like the cell phone industry, the investment industry has evolved over the last ten years. Why would someone keep an old Nokia 100 that is slow, ineffective and more expensive than the technologically cutting-edge iPhone 4? The same applies to financial products. Why would an investor stay invested in expensive, inflexible and complicated policy-based products when unit trust based products are available?
Financial products, like cell phones, have become smarter, easier to use and — more importantly — cheaper than their earlier versions. Unfortunately, many investors have not converted from their old financial products to the new models and are unable to capitalise on these valuable benefits. Ironically, these are often the investors who complain about the poor performance and fees charged within their financial products or portfolios.
It is important to understand that investment performance and investment fees are inextricably linked. Your effective return is based on the returns of the underlying unit trusts selected to construct your financial product. However, this return is diminished by the total ongoing costs you are paying to be invested in these funds.
So, when your portfolio delivers a lower return, your fees effectively account for a larger chunk. For example, if your portfolio delivers a 30% return and your total ongoing fee is 2% per annum, this accounts for a relatively small percentage (6,7% of your total return). On the flipside, if your return is only 10% then these fees make up 20% of your total return.
You are charged two types of fees on investment products: initial fees that are deducted from your gross investment amount and paid before your money is invested, and ongoing fees that are normally deducted monthly from your invested assets. Ongoing fees are percentage-based, meaning the higher the asset value of the investment, the higher the fee in rand terms.
These fees can either be paid upfront or on an as-and-when basis. Non-negotiable upfront fees were common in the older generation, policy-based products. However, one of the problems with this method is that punitive penalties are levied should you wish to amend your contributions or terminate your contract before the end of the contracted term. Legislation now states that no more than 50% of advice fees may be paid upfront.
Fees paid on an as-and-when basis are used by almost all unit trust based product providers, where fees are only payable when each payment is made, like a ’pay-as-you-go‘ cell phone. This method is in the best interest of you, the product provider and the intermediary. As intermediaries are not paid upfront, there are no penalties levied if you stop or reduce your contributions or transfer your investment to another product provider.
Where your fees go
There are three parties that can earn fees when you invest in a financial product: intermediaries, administrators and asset managers. Negotiable initial and ongoing fees are paid to your intermediary for guiding you in selecting the most appropriate product to achieve your financial goal. Initial fees can range from 0% to 3%, while ongoing fees are normally negotiable from 0% to 1% per annum and can be changed at any stage.
A fee is also paid to the administrator or product provider for delivering a range of services to the investor. Some administrators charge an initial fee that is calculated using a sliding scale, so the more you invest, the lower your initial fee. However, all administrators levy an ongoing administration fee.
A further fee is paid to the asset managers of the funds selected to invest the portfolio in. Most funds do not charge initial asset management fees and those that do normally charge 0,25%. Ongoing asset management fees vary from one fund to another.
Whether you are shopping around for a new cell phone or looking to invest your hard-earned money, understanding who and exactly what you are paying for — while not your only consideration — should play a big role in your ultimate decision.