The issue of costs when it comes to investing

There are many things that the financial services industry does not tell people. This is because there are aspects of the industry that are simply too technical for your clients to understand. For example, the debate between active vs passive investment will never go away, and quite frankly, your clients don’t need to know why it won’t.

However there are aspects of the financial services industry that are mostly being kept a secret; and in the world of open transparency, it is only fair that clients know about these so-called “secrets”.

Slow poison

According to Lance Solms, Head Itransact, one of the major secrets being kept within the financial services industry is the issue of costs when it comes to investing.

Every adviser reading this will sit back and say: hang on, there is quite a vociferous debate regarding costs when it comes to investing. Trade unions have even lent their significant weight to this debate.

While this is true, how many of our clients have an exact breakdown of why costs are considered the slow poison of the industry.

“Active and passive managers access the Top 40 indexes in their quest for alpha. Yet, active managers are charging significant fees for this privilege. Let’s say you want to invest R100 000 over 20 years where there is a promise of a 15% return. Over the full cycle of the investment, costs of 3% will lead to a deduction of 42% from your total at the end of 20 years. A fee structure of 4% will see this deduction climb to 50%. When one looks at costs within the industry, it is normal for an active strategy to bear costs of 4%,” says Solms.

He went on to question why the public is investing in funds where the costs are so high only to have access to the same vehicle they can access at a fraction of the cost.

Belief systems

In a way it comes down to brand awareness and brand association. Humans believe in and trust brands that they know. Look at Pepsi and Coke, or Levi jeans vs Mr Price jeans.

According to Solms, people will follow the top brands in the industry because they are told that these funds are the top performers. They even win top awards because of their performances. However, research undertaken throughout the world shows that the market will beat the returns of active fund managers by an average of 30% over a five year period and by close to 70% over a fifteen year period.

“If you invested R10 000 in the FTSE/JSE ALSI 40 index in 1995, and kept investing until 2015, your return would have grown to R155 129. People like to associate with brands; and in some cases that is fine. But when it comes to investing, clients need to be brand agnostic. They need to chase returns,” urges Solms.

Don’t jettison the adviser

Does this mean that there must be a Bridge Over the River Kwai march towards passive investment vehicles, which may be dominated in the future by online investment vehicles? Solms says no.

Let’s not discredit the good that these types of vehicles offer. They are accessible and allows the person on the street (with a little bit of guidance in some cases) to access the Top 40 indexes on the JSE to build up a savings portfolio. In other words, a miner in Marikana can potentially have access to the same basket of shares that a business person in Sandton has access to.

But at the end of the day, these are online vehicles and cannot be considered as proper advice. They ask you questions which set parameters, and then suggest an appropriate product (vehicle). “However, these questions do not change. Yes they set savings goals, but the savings goals of a 20 year old are vastly different to the savings goals of a 35 year old who is starting a family,” cautions Solms. He ends off by saying it is no good ignoring costs if you do not know what you are doing; in these cases, rather pay the 4% costs. 

The wind beneath your wings

Solms is an outspoken proponent of the adviser and says that a good adviser is the most valuable asset that you can have on your investment journey. He is simply reinforcing what the popular public perception is… people need to know what the costs are when it comes to investing.

So where does Solms stand in the debate between active vs passive? He says that there needs to be a combination of both. Costs cannot be completely stripped out of the equation if a person wants to invest effectively. Perhaps this is the basis upon which we can sit with our clients and have an open discussion about this taboo topic.

Editor’s Thoughts:
Rome was not built in a day, and the journey of a thousand miles begins with one step. But if your clients are going to participate in either empire building or wanderlust journeying, they will need a guide to show them the proper way. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].

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