Chapter 4: Investing for the future
Not all people are created equal when it comes to money. People have different needs depending on their age, and wealth. The factors that most influence a client’s future wealth profile are:
The level of wealth creation a person will undertake, often depends on the level of knowledge a person has. As a general rule the more educated the person the higher the level of resources (salary or income) they can access which increases the wealth creation ability. We can refer to this income and expense that a person will experience as their income statement. The income statement will reflect the amount of demands on the person’s income. A parent for example, will have to educate children, afford health care, schooling and food, so they cannot afford to take the risks a person with no children and the same income, may take.
This childless person may use that money, normally spent on children to invest in a property to let and so create more wealth. This in turn helps create more wealth, as they can take on more risk or invest in higher return funds due to the length of time they can invest. This leads to a situation where people who have a certain level of income, create more wealth out of the wealth they have. We call this passive income and eventually this income may actually surpass their actively earned income. Wealth is then created as the person can survive without a pay-check.
There are typically three kinds of fees that one can pay in a retirement or investment product
If you invest with more than one fund, you need some kind of administration platform to manage that. That administration platform does the recordkeeping for you, so that you get one investment statement for all your underlying portfolios. There’s a fee for that, those fees typically average about 0.5%, so if you are going to be investing in more than one company, through a LISP platform you are going to pay an administration fee. To avoid that fee go directly to the individual companies and invest directly in the funds there, unless that is not allowed by the company. Certain companies will not allow private investors unless they use a broker or financial advisor.
Retirement is very complex environment, and investment companies have made investing unnecessarily complex. To navigate this environment, brokers or financial advisors normally charge an initial fee. The industry forces the use of advisors because they are not able to give plain language solutions, as that can be construed as providing advice. Providing advice is not allowed except by a person who has the required registration. In this way the financial services environment works much like the legal world. It can be difficult to find a professional you can trust, or work out for yourself what is actually in your best interest. There are two types of brokers or Financial Advisers. One is tied to a particular company and only advises on those products, while the other is independent and will use a range of products from different product houses. The client paying the initial advice fee, will need to either pay the adviser upfront or create a separate loan account with the product provider, which is paid off over time from the fund or investment. The problem, clients find is that many brokers and advisors are not really independent, or educated sufficiently and should really be considered product salesmen.
Good advisors should be able to draw up a financial plan to work out how much money you need and how much you should save as well as where to invest the money. The fee charged should not exceed 3% of the investment. On-going fees may also be charged. The return an advisor brings with a monthly charge, should be in excess of the market performance of a passively managed fund.
Collective investments and unit trusts (mutual funds) also have an annual fee for their platforms and the fund costs. Costs include an administration fee for the investment platform, an asset management fee and an adviser fee. Index-tracking, or passively managed portfolios, are also available and cost on average about 0.3 to 0.35 percentage points a year less.
Funds should publish the effective actual cost and that is supposed to account for everything, your admin fees, your platform fees, your performance fees and your investment fees for the fund.
Compounding this fee problem is time.
If you’ve got 100 saved and you can earn 3 % per annum on that, you should have 103 at the end of the first year, being 3% on the initial 100. The next year you earn 3% on the amount of 103 which now is 3.09. The third investment period you would have 106.09 and 3% of this will give you 3.18 in return. If you can get an extra 3% on your investment over 40 years that’s going to have be an extra of 346 bucks in your pocket.
Investment fees also suffer from compounding in the same way. The result of this compounding effect is to strip your return and this is worsened if there is a lot of volatility in the market. The reason volatility can worsen the situation is that the percentage paid to the charges is taken off even if the market has not performed. In a fund that cost is recouped by selling units at a lower price – this means more units are sold for less money, stripping the asset base of the investment.
When we look at the fees and show the annuities after retirement it will be easy to see why charges are so important on the performance of an investment. For now we need to first understand another situation, risk.