We recently met with a new client who needed some guidance on her investment. 4 years ago, she sought advice on what to do with her R25 000 she had managed to save. After some time she grew weary of the situation as her investment appeared to be under-performing.
With the permission of our client, we are using her as a case study so that if you are in a similar boat hopefully we can prevent you from making the same mistakes.
Poor Performance – the Bad and the Ugly
When we start reviewing any investment we need to be aware that poor performance can have a good explanation. The economy, markets and your fund choice all play a big role in the volatility your investment may experience. In the short term and during a recession your investment has a probability of a negative return if you are invested in high equity portfolios.
It is crucial to invest objectively and based on your time horizon. Performance needs to be considered against your goals and your outcomes. When considering performance, we need to be careful of looking at 1-month returns when you have a 5-year plan.
In short, the Bad is when your investment value is lower than expected but you could be looking at your outcomes wrong or the markets could be in recession.
The Ugly
On the other hand, when considering performance, there is a possibility that the product costs and advisor fees could ruin any form of positive returns. Finding these fees and penalties can be a real challenge as some providers are not always willing to disclose this information.
The Facts
Off the bat these were some of the facts we were aware of by looking at the most recent statement:
As previously mentioned this investment in isolation could be put down to poor market conditions. This would be a bad scenario but we may be in for an Ugly scenario. Answering the 4 questions below will help determine the root problem of her investment.
- Was the advisor a Tied Sales Agent or an Independent Planner?
- Why was the investment administered by this Life Company?
- The two balanced funds did not have a negative return over 5 years so why was her investment negative?
- Why was the client invested in an Endowment?
1. Was the advisor a Tied Sales Agent or an Independent Planner?
Firstly, what is the difference? The difference between an Independent Financial Planner and a Tied Sales Agent is an independent financial planner needs to understand all the products, think holistically and be able to objectively look for the best solutions for their clients. Where a Tied Agent has one product provider and can only give advice on those products with their company.
In addition, Independent Financial Planner can charge clients a fee for services or receive a commission from the provider and a Tied Agent needs to make a sale to earn an income and can only earn a commission if you agree to sign up for their product.
The advice was given by a Tied Sales Agent, not an Independent Planner. She received advice on her investment by someone who would only earn an income if she invested in that product and no other.
A tied sales agent is limited by what they can offer
Independent planners can pick the best for each need their client may have
2. Why was the investment administered by this Life Company?
At Growmatter we believe in using specialists. Getting the best man or woman for the job gives you the best chance of a positive outcome. Life insurance companies should be used for life insurance, Investment companies should be used for investing.
Imagine the frustration if you need to buy a new fridge and the salesmen representing microwaves is trying to sell you a microwave. Microwaves are amazing but unless it can make and keep things cold you need a fridge.
Most people invest with life companies because of advertising, a call centre or someone recommended they speak to a person. Insurance Investment Products are complicated and they often have high fees that the client is unaware of. They need to charge higher fees so they can fund the commissions they pay upfront.
3. The two balanced funds did not have a negative return over 5 years, so why was her investment negative?
Investment performance for balanced funds in the last 5 years has not been the best with the average of the peer group returning 5.01% over 5 years. Not great but not negative.
We took the two funds in her portfolio and plotted the performance after investment fees. Looking at the chart below you can see Allan Gray have returned a positive of just under 6% after fees and Coronation a positive of just over 5%. How then is it possible for her to have a negative return?
There is a marked difference in the results of the investments and her returns which has to be attributed to product costs and fees.
After requesting several fee comparisons from the life company we were able to account for some of the fees in this investment. Below are some interesting figures based as a percentage of the initial investment.
Getting to grips with the exact fees and percentages are always challenging and there may well be other fees like a policy fee, product fee or marketing fee. One thing is clear though, not all investments are the same.
4. Why was the client invested in an Endowment?
The decision to use this investment vehicle doesn’t make sense with the client’s needs and situation. A unit trust with complete flexibility could have been a better option. There is one main reason to use an endowment and that is the tax benefits. If you have a very high marginal tax rate you can benefit from the fixed tax limits within an endowment. This client was well below the tax threshold and therefore would not benefit from any tax advantages.
The downside to an endowment is that your money has a minimum restriction period of 5 years. If a unit trust was used there would be no restrictions and the client would have no penalties for transferring or withdrawals.
The only upside we can think of is the upfront commission for the advisor. Life company products almost always require a client to sign in for a minimum term. This is how they can pay big upfront commission to the advisor and why the client is penalised if they do anything during this period.
In the end, it is clear that not all investments are the same and not all advisors are the same.
When evaluating products we do our utmost to ensure we are planning holistically. We need to take every financial aspect into consideration as well as also making sure that our clients understand what they are investing in and why.
At Growmatter our clients are reviewed annually, meaning we look holistically at their finances and financial goals and if things need to be changed, we make arrangements to realign their investments and goals.
For more information get in touch or ask us a question below.
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