Clarity on investment costs: Reduction in Yield decoded

When it comes to our investments, we all like to know exactly what we’re paying and precisely what we’re paying for. Unfortunately, determining the individual fees payable to your intermediary, administrator and asset manager can be challenging. In fact, it is still common practice for many product providers to disclose the total cost of a product as a single number, known as the “reduction in yield” (RIY).

RIY is defined in the South African Actuarial Journal as the percentage-point reduction in annual return over the period of saving that is equivalent in overall effect to the erosion of value due to all charges. For example, a RIY of 3.5% p.a. means that you will pay an average annual fee of 3.5% over the term of the investment.

As such, RIY is particularly popular in gauging fees in old generation products, where these fees tend to be lumped together and products are sold with fixed investment terms. However, we believe there is a more appropriate measure of fees for new generation investment products that are not bound by a specific investment term – especially when considering the assumptions that riddle the RIY calculation.

Firstly, RIY can by definition only be calculated using a fixed investment term, which most new generation products don’t have. The very nature of the calculation means that RIY cannot be applied on open-ended products.

It is also important to consider that the term used to calculate the RIY has a significant influence on the RIY percentage: The longer the term used, the lower the RIY. Investors should therefore be careful of buying products based on RIYs calculated over 25 and 30-year periods. The future is always uncertain and the products you have available are likely to change in the next 30 years. If you decide to move your money after five years, the actual percentage fee you would have paid would be significantly different to the RIY you were originally quoted.

The second limitation of RIY is that this measure is an average fee calculated over the entire contracted term. As such, the actual fee you pay on a year-to-year basis during the term will most likely differ from the RIY, leaving you with uncertainty as to what your exact costs will be over a given period. This is especially true if your product provider offers you a loyalty bonus, meaning that the longer you stay invested, the lower the fees you pay. As such, your fees in the first five to ten years of your investment term may be significantly higher than the RIY.

Your assumed investment return and the escalation of your investment contributions will further impact this measure. Increasing your expected investment return will decrease the RIY, but of course there are no guarantees as to how your investment will perform. And of course there’s the impact of costs that may be incurred should you wish to switch your underlying funds or punitive penalties that may be levied should you reduce or cease contributions once upfront commission has been paid.

RIY has gone a long way to assist investors in determining the costs of their investment products. It does, however, have its limitations and product providers should take the next step in disclosure by providing you with a full breakdown of the actual investment fees you will pay.