I had an interesting conversation with a prospective client recently. He wanted a review of his portfolio and recommendations on how he could improve his financial position. I noticed in the portfolio two retirement annuities (RAs): one worth over R650 000 and the other just over R100 000. He expressed some disappointment at the performance of the smaller RA, but was a lot happier about the performance of the bigger RA. He was contributing over R6 000 a month to the larger RA.
It seemed a bit odd that he’d be happy with the performance of the larger fund given how much he was contributing on a monthly basis, but he then explained that he had started with a smaller contribution which grew over time at a rate of 10% p.a. The investment started with an initial monthly premium of R2 000 a month 12 years ago.
I probed a bit further because given the performance of the market over the duration of the policy, I would have expected the value to be a lot more. So we decided to do a proper calculation to what the return was, because while he was satisfied with the portfolio, I was not convinced. In the end we calculated that he contributed just over R552 000 to the policy in total, and that the compound annualised growth rate of the policy was a meagre 4.1% p.a. – he earned less than inflation over the period and had, in fact, created no wealth from the investment.
He was very confused by the discovery that what he thought was a great investment was in fact a dog. How was it that he could have been under the impression that he was making money? Part of the answer was in the fact that he had been contributing to the fund for a long time, and he had lost track of how much he had actually contributed in total. Twelve years is a long time to keep track of how much he was contributing. Over that time his income had increased faster than the contributions, and so the investment became less significant in his overall budget.
The other reason that he was under the impression that his portfolio was doing well was because of what he read on the fact sheet of the fund he was invested in. Over the years the fund had reported good returns which the client was pretty happy with. However, those returns were before admin and other fees, and they were for lump sum investments not monthly investments. For example, the JSE All Share index (Alsi) delivered around 53% p.a. for the past three years, while a monthly investment in the Alsi over the same period is up around 24%. It is only the first premium that is invested for the full term; every subsequent premium is invested for a shorter period. Again, this was an important fact which the client did not take into account. Reading the fact sheet every year gave him a false sense of comfort around the performance of the investment.
The main detractor from performance was fees. He was invested in an expensive, old generation RA and the underlying portfolio was an expensive life fund which is not subject to the same disclosure requirements as unit trust funds. However, this was masked over the long term by the method of performance reporting and by the client not being fully aware of the extent of his contributions over the period. The result is that he developed a false sense of security about the performance of his investment.
This situation highlights the importance of reviewing one’s portfolio on at least an annual basis. This way potential issues can be detected a lot earlier and there is little scope for illusions to appear.