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Compound your compound interest

How to get your investment running while not paying too much in fees.
Percentage-based fees also enjoy the power of compounding, but there is a way to benefit from investment advice without paying for it in perpetuity. Image: Shutterstock

We all know the drill. Start early, be consistent, give it time, and then allow the jet fuel known as compound interest to blow your socks off.

The legend is indeed true – compound interest is a really powerful force that can do wonders for a financial freedom dream (or any other long-term financial goal).

But what if I told you there was a way to make compound interest even more powerful – compounding your compounding as it were?

Okay, time to meet the Smiths, a couple who have managed to carve out R5 500 a month from their budget. They have decided they aren’t getting any younger and want to put this money towards their retirement.

Option 1

Let’s walk with them down the road many people would take when faced with this situation. First up, they find a financial advisor. Maybe it’s the one their parents used or their friend’s connection, or perhaps they do a Google search. Either way, they find someone and arrange a meeting so they can get their investment up and running.

Now let’s say this advisor is actually semi-decent, independent and not just after fees. The advisor realises that because both the Smiths have a pension fund at their work, it is probably better to diversify their tax treatment a little bit, while at the same time getting them some additional offshore exposure by putting them in tax-free savings accounts (TFSAs) and not a retirement annuity (RA) – see I told you the advisor wasn’t just fee-hungry.

And would you look at that – it just so happens that the R5 500 the Smiths have available to invest is the exact amount they need to max out two TFSAs. Wow, what a coincidence.

Okay, let’s assume the advisor puts them in a cheap, passive, equity-focused, offshore investment (maybe something like the Satrix World; I say again, this advisor is a good one) that gets them a 12% annual return. Let’s say the advisor takes what seems to be the industry standard fee of 1% per annum (with Vat included that equates to 1.15% per year).

There’s nothing unusual about any of this and off the Smiths go on their investment journey.

Fifteen years pass, and in that time, the usual market crashes and recoveries happen, maybe the Springboks win a world cup, and I even get around to finally fixing the light my wife keeps nagging me about.

The Smiths’ TFSA investments end up at a combined value of R2.347 million. Not too shabby.

Option 2

Okay, now let’s consider another path the Smiths could have taken. You see I forgot to mention that Mr and Mrs Smith have been a little stressed out lately and they could really use a holiday – and we’re talking international.

So instead of starting their investment, they decide to stash their money away for six months. They then take the R33 000 they have saved up and go on an epic overseas trip.

But something else happens during the six months when they’re saving for the holiday …

Mrs Smith starts listening to the Just One Lap Fat Wallet podcast every Monday on her way to work. And Mr Smith spends about 30 minutes a week reading up about investing on news sites, googling the stuff he doesn’t understand, and even starts following some personal finance blogs (okay, maybe I am a little biased, so I had to throw that last one in there).

Little by little, the Smiths start gaining some knowledge. It doesn’t feel like it, but small incremental gains each week result in them accumulating a decent amount of investment smarts.

They learn things like:

  • For a long-term investment, you need to have some growth assets like equity.
  • Diversification is important, as it can reduce your risk and enhance your returns.
  • Passive exchange-traded funds (ETFs) are low cost, and because they track the market, they don’t run the risk of underperforming the market.
  • A TFSA can be a great alternative to an RA.
  • When investing for the long term, you need to ignore the media noise and prophets of doom. Markets go up and markets go down – selling when markets are down is a terrible idea.
  • Patience is important, and it’s the time in the market that counts.

After their holiday (a full six months after the scenario where they started investing through a financial advisor) they finally open their TFSA accounts themselves and start DIY-ing their R5 500 a month investment.

Now, bearing in mind that starting early is one of the most important factors when it comes to investing, and in the second scenario the Smiths have lost out on the first six months of contributions and growth, do you think their investment would be worth more or less than the first scenario, where they started immediately but used a financial advisor?

Well, the results are in …

Source: Author

Yes, that’s right – despite starting later (and losing the most important first six months), contributing less, and having the investment run for a shorter period of time, the Smiths ended up R100 000 better off than if they had started immediately through an advisor (R100 000 – that’s enough for some more international holidays in retirement).

The main reason for this is due to the R154 000 in fees the Smiths would have paid for using the financial advisor.

You see, compound interest gets some rocket fuel when there is no drag of an advisor charging a percentage-based fee.

And remember, when it comes to fees, it’s not just the money that gets paid over, it is also the lost compounded growth that money would have had if it had stayed invested instead.

Compound fees are the nemesis of compound interest

Yes, I get it – investing can get scary, especially when the markets pull a wobbly or the returns go nowhere for five years (I won’t mention any names *cough* JSE All Share Index *cough*). In times like these, you can call up your advisor and they will tell you: “Don’t worry, everything is going to be okay. Just keep at it; this is pretty normal and par for the equity investing course.”

For many people, this can be really reassuring. But you’ve got to ask, is it worth paying R100 000 for? Heck, drop me a mail and I will tell you all those things for free.

But maybe I’m being too harsh. Maybe there is a middle ground to the fee-versus-guidance issue?

Well, I think there might just be.

Allow me to present one more scenario to you.

Hacking the financial advisor system

To understand how you can get the best of both worlds – some guidance to get your investment up and running, while not paying too much in fees – let’s first look at the rand value the Smiths would have paid in fees for each year they used a financial advisor:

Source: Author

Interesting. That looks a lot like a compounding chart, doesn’t it?

That’s because it is!

And this is the problem with percentage-based fees: as your investment grows exponentially, so do the fees.

In year one, the Smiths would have paid a palatable R428 in fees. But in the last year, they would fork out over R25 000. Eina!

In fact, the fees paid in the last year alone would be more than the combined fees of the first seven years.

And remember, I’m only showing a 15-year timeframe. If this investment runs longer (as many retirement investments will) the fees will continue their exponential march ’til they get to the moon, circle round and then bite the Smiths in the behind.

So here is what I think is a good compromise for someone who wants to start investing and would like the guidance a financial advisor can provide, but is maybe put off by paying too much due to percentage-based fees.

Let’s see what happens if the Smiths set up their investment through a financial advisor, and then during the first three years, while the advisor’s fee is reasonable, they gain some investing knowledge, start understanding how it all works, and then take over the investment themselves at the start of the fourth year.

This is what their investment would look like (versus the scenario where they went on holiday and delayed their investing by six months):

Source: Author

In this scenario, they end up with over R2.6 million. That’s more than R150 000 better off than if they went on holiday and delayed their investment by six months, and a full R250 000 higher than if they had kept the advisor for the full 15 years.

Now I don’t know about you, but taking some time to learn a little bit about investing seems like a small price to pay in exchange for R250 000. And doing it at a leisurely pace over three years doesn’t seem like that big of an ask at all.

Okay, let’s wrap this all up really quickly by summarising the investment outcome, contributions made, and fees paid for each of the three scenarios:

Source: Author

Investing through a financial advisor results in an ever-growing and compounding fee bill, as well as some serious lost growth on the money that was paid away in those fees.

The Smiths’ investment outcome was significantly improved by taking some time to learn DIY investing. This skill is so valuable that they were able to achieve a better outcome even after missing the most beneficial first six months, going on a holiday instead, and contributing less in total.

But the best scenario is the case where the Smiths start their investment immediately through a financial advisor, but then go it alone after three years. Yes, there are some fees to pay, but that number doesn’t even register on the chart above.

And it is this scenario that I think pretty much sums up everything I want to say:

  • Starting early (as in right now) is super-important.
  • It’s so important that even if it means starting your investment by using an advisor, that is fine. But …
  • Once your investment is up and running, costs become really important. Spend some time to educate yourself, because percentage-based fees quickly become a total rip-off, and learning to invest on your own could be one of the highest-paying skills you will ever learn.

Yes, it’s true – you are not going to learn everything there is to know about investing overnight. But putting in a little bit of effort on a regular basis, over an extended period, will prove to be well worth the six- or even seven figures you can save in fees.

This article was originally published on the Stealthy Wealth blog here

The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.


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SIGN IN SIGN UP this with a broad smile …music to ones ears

Wise advice that financial investment know-how is not hard to come by if one is willing to investigate & learn

Advice I give my kids and still remind them of

Thank you Stealthy Wealth

Agreed 100% but I think SA is tricky ground. Factor in the current economic climate, inflation/ZAR depreciation and tax and you have to look sharp to realise real gains. Even from compound interest. Looking in the mirror to go forward is particularly tricky right now methinks.

A very poor article. Here is some free advice (that you can compound with) for the author.

1. There is only one way to compound. That is with a dividend or a distribution (e.g. from a property stock or interest from a bond)
2. Checked Satrix website – the world index fund doesn’t distribute any dividends or distributions. Even if there was a distribution paid (due to foreign withholdings tax) it would be so minuscule as to render it irrelevant to generate any meaningful form of compounding. Therefore #zerocompounding!!
3. Fees are an important topic – they affect investment returns. Your yield after fees is important, because the yield can be re-invested to buy new shares or units in a unit trust to create compounding (compounding is new shares / units bought with re-invested dividends). In this case, if you had high fees or not, you still would have almost nothing to compound with. However, the fee would affect the investment return.

Compounding is a force to be reckoned with. No one would argue that. To get compounding you need a dividend / distribution. What the author is referring to in this article is capital growth. Capital growth just doesn’t happen in a straight line at 12% per year like the article suggests. Neither does capital growth compound. You get capital growth (on a basket of shares) if the the value goes up. You can’t re-invest the growth (assuming you got some) in to new shares (#compounding). If you got growth and sold your shares and re-invested, then you would buy back at the same price you sold at. Hence you end up with the same number of shares (therefore no compoumding). The article has compounded capital growth which doesn’t happen in the real world at all. It shouldn’t exist in a fake world either. *cough* MSCI doesn’t go up at linear straight line 12% a year (remember the lost decade of returns in the US and UK where returns were near zero for 10 years) and neither does *cough* JSE All Share Index go up in a straight line. The JSE All Share Companies do create dividends to compound with, and that is nowhere to be seen in this article.

What the article has shown, is that investing for the long-term in growth assets is a good idea. The longer you invest the better (rule of thumb). This isn’t always the case, but is a generally accepted truth.

What your comment shows is that you absolutely don’t know what you are talking about.

1. The underlying Satrix fund (iShares Core MSCI World UCITS ETF) shows performance “on a Net Asset Value(NAV) basis, with gross income reinvested where applicable”. This is from the iShares website. This is a total return fund which means they do the reinvesting on behalf of investors. When you re-invest, you’ll get compounding.

2. Same when you re-invest capital growth (leave it in the market). If the market level goes up 10% in the first year (ignoring divis) and 10% in these second year, then you are up 21%. In the second year, you are up 11% on your starting capital, not 10%. That’s compounding.

Your second last para is complete nonsense. The fact that the illustrative return quoted by the author does not happen in a straight line is irrelevant in the context of compounding. Whether you can expect to earn that 12% return on average over the period is another matter, but is not the subject of this article.

Sometimes it’s better to not post and let everyone believe you are clueless (or an adviser), than to post, and remove all doubt.

I think the essence of this article is to educate yourself to avoid fees from advisors and start early to invest. Its true in the investment world nothing goes in a straight line but let us agree it goes up anyway.

This is the problem with provident funds, great tax benefit up front but the fees are ludicrious. Alex Forbes charges a % of your salary because they think that is reasonable by some means.

I have therefore found that I have effectively wasted half a decade investing largel sums with enforced AF provident funds and now doing everything I can to get out of that.

If you are earning a lowish 5% for a period and your fees are 5% then you are losing about 5% a year to inflation and that’s roughly whats happened. Luckily still invest elsewhere but that Alex Forbes provident fund investment is the worst I think I will have to make and unfortunately a lot of companies enforce these terrible investments. I must say the provident fund vehicle still makes sense but not with those fees.

Love all the articles exposing FAs for what they are. At least real estate agents just dip once.

Anything,real estate agent fees dips much deeper. First a a huge lump sum and then a 20 year interest payment on that amount as part of your bond.

Regarding this article in regards to any service. Lets DIY our car service, our legal service our medical our event planning our recruitment and labour relations…heck why are we paying anyone anything…carwash is easy

Financial advice for the man in the street who is not financially astute requires professional advice (some of us who read about personal finance and are confident enough to DIY may be the exception, rather than the rule). Ditto for the man who has a medical, legal or dental problem – they need professional advice. In every profession you pay a fee for your time…..well, every one except a financial advisor.

If one is a person of principle, either
1. We all pay our GP, dentist, plumber and financial advisor a percentage of our net asset value to ensure that they take jolly good care of us in the long-term (long-term health, dental health, plumbing, wills etc)
2. We pay a fee for time spent on work to all of these professions

To make one profession the exception to the above strikes one as unprincipled.
(I once offered a financial advisor double my hourly rate as a medical specialist: he declined. Enough said)

There is a difference between paying someone for a service and giving them a percentage of the value of your car for cleaning it. A child can see the difference.

FocusDougall, your comments actually better than the article, again, without being technical, my experience now after 25 years of investing I a RA and unit trusts with one of the biggest Fund Managers in SA is that compounding (as you said interest and dividends) only starts working in your after about 23 years, dont worry abt capital growth, thats another subject,and I’m sorry to but not even Tarryn Lamb from Allan Gray seems to understand the concept of compounding after I had a personal discussion with her at one of their “investment seminars”

Patrick – Tx a reasonable article on the impact of ‘costs’ on investing; albeit asset manager fees, adviser fees, implementation costs, product costs – ongoing % fees being the most detrimental. Any cost reduction would be beneficial on gross investment return, but clients actually receive net returns (ie after costs, CGT, Income tax etc).

Advice fees should be de-linked from performance, unless delta (value provided by advice) can be shown of an advisor’s actual contribution to the performance of an investment(?).
Fees as a % of asset under management is an archaic method of payment instituted by ‘product providers’ – as a less client intrusive and easier method to pay advisers.
The issue being – clients are not informed appropriately of the real impact of % based ongoing fees versus a fixed ZAR based fee (for value of advice dispensed).
Finance is extremely specialised – consumers requiring financial guidance/advice need a how to guide to elicit the appropriate financial information to help them make an unbias informed decision.

Good article;it’s hard to quantify the value of advice when it comes to long term investing.Because regardless of any ‘expert’ advice you can get,the chosen strategy or portfolios thereof might just underperform the broader market.Financial advisers are burdened by employer performance targets,even independent ones are mostly sales driven.So the value they add is suspect.
Even though it can’t solve all problems,DIY is a viable solition

The interests of advisors and investors are virtually diametrically opposed, namely to make as much money each year from the client’s assets under management. The more the 1 party makes, the less the other makes. Compounding is both a wonderful thing (of returns) and a disaster (compounding of costs).

R100k in 15 years (+-R48k in today’s money @ an assumed 5% inflation); hardly enough for 1 overseas holiday let alone many.

You seriously overestimate the average person’s interest in “understanding how it all works”. It’s easy to assume an average 12% per annum, but that’s not what you get in reality. What do you think the average person with very little investment knowledge is going to do when they experience a 30%/40%/50% drop in the value of their portfolio?

What amazing strategy will a financial advisor give someone to rectify a 30/40/50% drop in the value of their portfolio.

Ah- they dont need to advise anybody because they will still collect their commission regardless. I’ve been DIY’ing and getting by just fine. My cousin who works for FNB as a financial advisor makes terrible investment decisions for himself and has to always borrow money from the family.

You think I can trust them to make decisions for me? The risk is exactly the same- consultants or not. Just keep your portfolio diversified, load up on ETFS, max out your TFSA, some RSA retail bonds, some into your RA, some in Tyme bank and you will be fine 🙂

But the author is “advising” a 100% equity investment to people with very little investment knowledge, which in my view, is irresponsible. A multi-asset high equity fund is probably most suitable for your average investor in their accumulation phase, thus (hopefully) avoiding those 30%/40%/50% drops altogether. Ask those invested in the Investec Value Fund how the last few years have been, quite a wild ride.

There are a plethora of studies on investor behaviour that show how investors shoot themselves in the foot by switching out of asset classes and funds at the exact wrong time.

I don’t have an adviser either, but there are quality advisers out there working for independent wealth management firms. I definitely wouldn’t seek advice from tied agents at large insurers and banks. Read Vanguard’s research on adviser alpha.

Oooh ……
Financial advisors aren’t going to like this article!
But I’ve always wondered why you pay someone else to make financial decisions when you’re taking all the risk! Insane.

End of comments.





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