Which would you choose as a retirement vehicle over the next 20 years: a product that deducts 8% of your monthly contribution with no annual fee, or a product that has no upfront fees but a 1% annual fee?
Logically we would opt for the no upfront fee. Surely the more we invest upfront, the more chance our money has to grow and, quite frankly, 8% is ludicrous. The 1% sounds far more reasonable.
But interestingly the figures prove otherwise. Take for example a R2 000-a-month investment that you continue to make for the next 20 years. The growth on the investment is 12% per annum.
Example one:
You invest R2 000 a month for 20 years. There are no fees and the investment grows at 12% a year. At the end of the period you would have a lump sum of R1 970 000.
Example two:
The same investment as above except here you have paid an upfront fee of 8% on each monthly contribution so that your net monthly investment is R1 840.
At the end of the period you would have a lump sum of R1 820 000. Your costs over the period have amounted to R150 000 and you have received 8% less on retirement (known as a reduction on yield).
Example three:
The same details as example one, except there is an annual fee of 1%. So your R2 000 a month is fully invested, but the product deducts 1% of the total value of your investment each year.
After 20 years your investment would be worth R1 731 000. Your costs have amounted to R239 000 and you have received 12% less on retirement.
The reason is that the 1% fee is affected by the power of compounding growth. The 1% fee is charged on the total value of the investment. By the final year that is 1% of R1,7-million which is R17 000 compared to the 8% on the upfront contribution which would work out at R1 920 for the year.
No wonder more and more advisers and product houses are waiving upfront fees and opting for annual fees.
However, you need to be careful about applying this as a blanket rule. For long-term investments, the ongoing fee is far more expensive. However, over a shorter-term investment of five years the annual fee could work out as a better option as the compounding effect is not as great. It also depends on what the relative upfront and annual fee options are.
For example, over five years the upfront fee is 5%:
R1 900 is invested each month for five years growing at 12% = R155 172
There is no upfront fee but an annual fee of 1,5%:
R2 000 invested growing at 11% (12% less the fee) = R159 036
Many investment houses now use reduction in yield to demonstrate the effect of fees. Make sure those figures include advisory fees and also make sure you understand the financial implications of your decision.
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