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Better investment growth due to lower costs

I was about 10 years old when our school took part in a charity event for which we had to sell raffle tickets to raise funds.

To motivate us, a prize was offered to the child who sold the most tickets. Extremely eager to win the prize, I set off proudly to our rich next-door neighbour shortly after school with a terrific sales proposal.

I had barely started with my sales pitch, when he stopped me abruptly by saying: “No thank you.”

Quite stumped, I pleaded with him: “But you’re a millionaire and this book costs only R2.”

And then this man gave me my first lesson in cumulative growth by answering: "Do you think I became a millionaire by simply giving my rands away? It was through saving them that I became rich."

I recently read a 1975 letter to the Washington Post, authored by Warren Buffett (then aged 44), on how to manage pension funds. The letter consists of a total of 19 pages, but in short, it comprises the following:

  • If consistent above-average returns are fund managers’ main objective, a vast majority will fail. Will some of them succeed by a stroke of luck or perhaps even expertise? Absolutely.
  • He mentions that he is almost certain that above average returns cannot be maintained with large amounts in managed capital.
  • In short, the rational probability of consistent and guaranteed above- average returning pension fund management is close to zero.
  • I was quite shocked to discover that up until the end of August 2016, only 17% of all general equity unit trusts managed to outperform the stock market’s total return over the last 12 months.

Historically, I also discovered that this is no isolated case. So, as the person the street, what can I do to ensure maximum growth in my pension fund or investment if I have almost no control over the success of my investment manager?

By paying more attention to the things you do have control over, and which can, ultimately, help you to achieve better returns over the long term.

On a daily basis, we are exposed to adverts from investment institutions, both based locally and offshore, who each claim that they are the best of the best. In the end, there are only a few basic products like Linked Investment Service Provider (Lisp) investments, retirement annuities, endowments, provident and retirement funds on offer, each of which is nothing more than a container, and each offering more or less the same number of benefits and disadvantages in its own right.

I don’t care about the colour of the container. All I care about is that if I’m looking for a monthly investment plan, for example, and I know exactly which funds I’m going to place inside this container, and what the container will cost me.

If we take two of the largest investment institutions in South Africa – both LISPs (let’s call them companies A and B), and assume that I can invest R1?000 a month over the next 20 years with an annual premium increase of 10%, company A will charge no initial fee but will charge an annual platform fee of 0.25%. Company B, on the other hand, will charge a 2.5% initial fee on my monthly premium with an additional 0.5% annual platform fee. Both of these companies claim to deliver a great service at competitive rates. Will this 2.5% initial fee (a mere R25 a month) and higher annual fee of 0.5% make a considerable difference to my investment growth?

Of course it will. If both platforms were invested in the same fund that yielded a 12% annual return over 20 years, my Lisp investment in Company A would be worth R1.9m after 20 years, compared to Company B’s R1.8m over the same period. Neither luck nor much expertise was involved. By simply making an informed decision and by not carelessly spending my rands, I could have added an extra 5.5% in value to my investment.

Be vigilant when examining the fees charged on your investment, and make sure that you understand the effect these fees can have on your investment growth before you invest.

Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 13 October edition of finweek. Buy and download the magazine here.

 

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