I am 22 years old and would like to start [investing] with a low-cost annuity. I just started working last year so I can contribute about R1 250 per month to a fund (increasing 10% per year or more depending on professional qualifications gained, experience, promotions etc.). I have set aside R25 000 just to give my chosen investment a bit of a head start.
The question is as follows: what fund or company should I rely on? My financial advisor proposed starting with the Sanlam Cumulus Echo Retirement Annuity and this plan has fees of 4% upwards.
What about 10X and Sygnia, which have much lower fees than the rest? Do I make a decision like an old realistic man and choose a retirement plan from well-known companies like Allan Gray, Sanlam etc.? Besides the fact that high fees take a huge bite of your growth, I am concerned about the longevity of such an entity. Will it still be around in 35 to 40 years?
Janet Hugo - Sterling Private Clients (Pty) Ltd
I really appreciate the sense of urgency of this young person to think about and do something about their retirement planning. Well done. To get the best compounding leverage, the sooner you start with a retirement plan, the better. There are several calculations to prove this, but I think your questions around fees and which company to use are also important.
There are two types of retirement annuities offered in South Africa. Those offered by a life insurance company like Sanlam, Discovery, Liberty etc. or those offered by a linked investment service provider (LISP) platform like Allan Gray, 10X, Glacier and others. South Africa has a robust financial services sector and as long as you or your advisor do your homework to choose an investment offered by a substantial institution, I feel confident that the longevity of the companies you choose to invest with are not the biggest problem you face. I am assuming you will be alert to any changing risk environment after investing as well.
Life company products (like the proposed Sanlam Cumulus Echo Retirement Annuity) tend to be somewhat rigid. In essence you would enter a contract with the life company to pay your premiums plus increases for a certain number of years and you will remain invested until age 55 or later. It is likely that if you invest in a life company product you are agreeing to pay your financial advisor in advance for all those years of service still to come, assuming the advisor provides ongoing advice and support the way he should.
Another issue is that should you make any changes to this contract, the life company is within its rights to apply expensive penalties to your saved capital, which would reduce real returns. I’m really not in favour of paying for financial advice in this way.
While you probably have every intention of contributing to these retirement savings on an ongoing basis and increasing your contributions over time, you need to remember that life is often full of surprises.
Let’s have a look at some potential curve balls: assume a new employer insists you become a member of the company pension fund and your total contributions of your salary are now more than the legislated 27% maximum. Or you could be offered a job outside of South Africa for a while. Either of these happy scenarios would lead to you needing to make changes to your contribution or your planned increases of 10% per annum. The life company would be entitled to apply expensive penalties.
You have correctly pointed out that fees tend to be higher in these types of retirement vehicles. So you need to compare the effective annual cost (EAC) across the proposed investments. The EAC also enables us to value and account for so-called bonuses offered by some companies, as well as all other costs, right down to stockbroking costs within the unit trusts. Pay attention to the EAC both in the short and long term.
When you compare the fees of unit trusts, make sure you compare the total investment costs (TICs). The TICs will include transaction costs and the total expense ratio (TER), which includes any performance fees.
It’s often surprising what the real total cost is, compared with marketing material that may only emphasise the competitive portion of the total cost.
An analysis of the EAC that we did across eight different companies showed that life companies struggle to match the costs offered by a LISP platform. For investors to reap the rewards of the bonuses offered, usually takes many, many years. Calculating the real costs is vital, because compounding high costs hurts returns and while you wait for bonus rewards, your life and your needs can change. You need to assess whether waiting out long contract periods is realistic.
What am I suggesting? At Sterling Wealth we believe in keeping investments appropriate for your needs and as simple as possible. After all, what is it you need? Capital growth at reasonable risk, with some flexibility. We believe that most investors would probably be better off using a flexible LISP platform that gives more investment choices, as opposed to a platform offering only index trackers. The LISP platforms will not penalise you should you stop your contributions or make other adjustments. Well-known companies like Allan Gray and Glacier offer investors a large range of active unit trust strategies and fund managers to choose from, as well as various index trackers.
Your EAC calculations may show that it might be slightly more expensive to use a LISP platform in the beginning than going directly to an index tracker platform like 10X or Sygnia, however, longer term, the additional investment flexibility may deliver a profit edge. Also remember that while index trackers have their place, so-called passive investing in trackers is a cyclical strategy and will not always outperform as well as they have in recent years of soft interest rates and quantitative easing.
A good advisor helps you understand what you are investing in and the potential value of bonuses and increasing contributions over various time scenarios.