When it comes to investing, understanding how fees compound over time is crucial as they can significantly impact your long-term financial goals. Whether you're investing directly in a unit trust or fund or using a financial advisor and a Linked Investment Services Provider (LISP), being aware of these fees is essential.
Fees for unit trusts or funds are typically displayed as the Total Expense Ratio (TER) or the Total Investment Charge (TIC). These figures, which are required by law to be shown on marketing materials or fund factsheets, include costs like management, trustee, legal, and audit fees. The TER covers the ongoing fees, while the TIC includes these plus the costs of buying and selling assets within the portfolio. Actively managed funds often have higher fees than passively managed funds or ETFs due to these transaction costs. These fees are shown as a percentage of the portfolio’s net asset value and can change over time.
Different investment platforms have varying fee structures tailored to their services. Platform fees cover the administrative aspects of your investment and are usually expressed as a percentage of your total investment. Local platforms typically start around 0.50% (exclusive of VAT) and often use a tiered approach, where fees decrease as your investment grows. Some platforms offer family rate incentives, allowing family members to consolidate their investments for a lower overall fee.
Financial advisors charge for their expertise in guiding you through your investment journey. They usually have an initial fee ranging from 0.50% to 3.00% for setting up your investment plan and an ongoing management fee between 0.25% to 1.00% for continuous advice and oversight. These fees are also a percentage of your total investment.
The Effective Annual Cost (EAC) includes all these fees—TER or TIC, financial advisor fees, and platform fees. Knowing your EAC gives you a complete picture of the costs associated with your investment.
Over time, fees can add up and significantly reduce your investment returns. Here are a few examples to illustrate this:
Example 1: The Power of Small Percentage Fees
If you invest R100,000 with an EAC of 1% and an average annual return of 7%, your investment would grow to about R386,968 over 20 years without fees. With the 1% fee, you’d pay roughly R70,000 in fees, leaving you with R316,504.
Example 2: The Effect of Higher Fees
If the EAC is 2%, using the same initial investment and return, your investment would grow to about R258,343 after 20 years. The higher fee significantly reduces the final value of your investment.
Capital Gains Tax (CGT): Selling or rebalancing your portfolio may trigger CGT, depending on your investment structure. The CGT inclusion rate is 40%, with an annual exclusion of R40,000 for individuals.
Tax on Distribution: Dividends and interest income from your investments can incur taxes. Local dividends in SA are subject to a 20% withholding tax, while interest income has specific tax exemptions depending on age and amount.
Performance-Based Fees: Some asset managers charge fees based on performance, which can apply to private equity funds and other investment products.
Studies by Vanguard have shown that portfolios managed by financial advisors often outperform those managed without advice by up to 3% annually. This underscores the value of professional financial advice, even when considering the fees.
Understanding and managing investment fees is vital to maximising your returns. By being aware of these costs and working with a knowledgeable advisor, you can make informed decisions and secure a more prosperous financial future.