Effective Annual Cost
Why is there not enough conversation around these three words, “Effective Annual Cost”?
As Independent financial advisors, we should pride ourselves in the fact that we are not tied to one company. We have a vast variety of investment companies to recommend to our clients and we should be analysing their options with a true non-bias approach.
We should all be extremely aware of the compounding effects that these costs attribute to the nett return at the end of an investment term. However, we cannot look at costs alone.
I often find myself wishing I had a glass ball that I could look into that would tell me exactly which funds will perform the best over the next 5 years. The reality is, is that we don’t know. Our clients trust us to analyse the choice of funds and select a “perfect” combination based on their needs, purpose, time horizon and wealth pool size.
Don’t be scared to use smoothing funds especially for clients who do not have the appetite for volatility or understand market movements. There are smoothing funds that have outperformed balanced funds and provide a sense of security with a level of guarantee that specific clients require. You might ask, well what is a smoothing fund? Effectively what a smoothing fund does is it will reserve part of the return when the fund performs well to combat low returns during market lows. This effectively gives you a smooth consistent return for example of 6% when some balanced funds are performing at negatives or possibly a 12% return when some balanced funds are performing at roughly 17%.
With the performance of many balanced funds lately, we have seen some outstanding results from smoothing funds purely based on the way they are structured and the reserves that they carry. These are extremely useful to also utilise in an Employee Benefit scheme. We as advisors need to make sure that we are happy with the portfolio managers managing the funds that we advise for our clients. Reality is, is that we should not be looking at past performance as it is not a true reflection of future performance. We should be analysing the shares that are held within those units and who the fund managers are that are managing those specific funds. That is quite a task at hand especially considering that we have thousands of funds to choose from.
My advice to you is to team up with a company or companies that do the analysis, giving you the confidence to make an informed decision. Taking Effective cost into consideration and being confident in fund choices could lead to the difference of an inflation beating return or an “I’m sorry the markets have been really bad” conversation… Take cognisance of both whilst guiding and advising.
Units vs Shares
To know when to recommend a unit-based portfolio or share portfolio may not be something that you have even thought about. When investing in units you are pooling your money collectively and relying on a portfolio manager to make informed decisions regarding the types of shares that they purchase to create a specific fund. You cannot phone that portfolio manager and ask him to adjust allocations or change stock picks to suit you as this is a pooled amount and the decision lies with the portfolio manager.
My advice to you is to build a relationship with share portfolio managers that can create individual portfolios for your clients. We have these available on most platforms. This is not something that we can look at for every client but for your higher net worth individuals or individuals who have portfolios of more than R 1000 000 it is something that you should consider. Using a share broker to partner with will create a unique and fresh way for your clients to invest. Their portfolio can be adjusted at any time with specific shares suitable to them. For those of you who do Employee Benefits, look for opportunities within your funds, certain companies allow “Executive type members”, based on their contribution and fund value to invest using a stockbroker. Be that advisor that opens that door for them.
Taxation is so important to consider when advising a client on the type of vehicle to invest in. By that I do not mean the tax that you will be paying based on your commission but rather the tax your client will need to pay??? Consider the following:
Does your client have a Tax-Free Savings plan? If no, then why not? This should be your first point of advice. Low costed, fully liquid and no tax on the maximum contributions of R33 000 per annum and R500 000 in a Lifetime. What a win!!!
Endowments – Yes, we all know the comm is great, but remember guys if you put your client first everything will follow. These should only be used if your client is paying tax higher than 30% in their personal capacity and if they are happy to be restricted to two accesses within the first five years.
Unit Trust – This platform is ideal for investors who pay tax of less than 30% in their personal capacity and or need the investment to be liquid.
Retirement Annuity – Great tax benefits now but will you be taxed later. I love the fact that you cannot access a RA before age 55 so that you don’t steal from your future you. Don’t forget to explain Regulation 28 or the maximum of one third that may be taken as cash at retirement, the reminder must be used to purchase an annuity.
Collectively, I believe that these all contribute to a successful, average or plain old horrible outcome for your clients at the end of their investment journey with you. Analyse, be honest and succeed. You can’t go and run the Comrades without training at all. So, if you do the groundwork well, the rest of the course will be easier. Disclose as much as you can to your clients and discuss your upfront and ongoing fees, these are paid directly by your client. Earn what you are worth not what you feel you are entitled to.
Corporate Consultant and Independent Broker