What investing really costs: fees explained

Why costs deserve your attention

Nobody can control what markets will do. Costs are different: they are disclosed, you can ask about them, and you can compare them before you commit.

Investment fees are easy to overlook because they are rarely invoiced. Most are quoted as a small yearly percentage of your investment’s value and deducted quietly inside the product, so you never hand money over.

That does not make fees a bad thing: managing money, keeping records and giving advice all cost something to do well. The aim is not to pay nothing, but to know what you are paying, to whom and for what. For most investors the costs sit in three layers.

Layer one: the fund’s own charges

When you invest in a unit trust or a similar fund, the cost of running it is taken from the fund itself. Two measures describe it:

• Total expense ratio (TER). The cost of managing and administering the fund over a period — the management fee, any performance fee, and items such as audit and trustee fees — shown as a percentage of the fund’s average value.
• Transaction costs (TC). What the fund paid to buy and sell its underlying investments. A fund that trades more often tends to show a higher figure.

Added together they are often shown as the total investment charge (TIC). All three generally appear on the fund’s fact sheet, formally called a minimum disclosure document. They look backwards — each reflects what the fund actually spent over a past period — so they can change from year to year.

Layer two: platform and administration fees

Many investors hold their funds through an investment platform, sometimes called a linked investment service provider. It lets you hold funds from different managers in one place and handles debit orders, switches, withdrawals, statements and tax certificates.

For that it charges an administration fee, generally a yearly percentage of the value you hold there, often on a sliding scale so that the rate is lower on larger amounts, and usually collected by selling a few of your units at regular intervals.

Investing directly with a fund manager may mean no separate platform fee, but your choice is then usually limited to that manager’s funds. Products from life companies, such as some endowments and retirement annuities, may carry policy charges of their own, and some older contracts charge for stopping or reducing contributions early — ask what a change would cost before you make it.

Layer three: advice fees

If you use a financial adviser, the advice is usually paid for in one or both of two ways:

• An initial fee. A once-off amount, generally deducted from your contribution before it is invested, for the planning and set-up work.
• An ongoing fee. A yearly percentage of the value of the investment, usually deducted in instalments and paid over to the adviser, for reviews and continued service.

On investments these fees are generally negotiable and are agreed with you in writing — nothing should be deducted that you have not signed for. On some insurance-based products the adviser may instead be paid commission by the product provider, within maximums set by regulation. Either way, the adviser must disclose what they earn, and it is reasonable to ask what service an ongoing fee pays for.

How fees are disclosed: the effective annual cost

With layers charged by different companies and quoted in different ways, comparing two investments used to be difficult. The South African savings and investment industry therefore adopted a common standard, the effective annual cost (EAC).

The EAC is designed to show, in one table, what an investment is expected to cost you each year: investment management charges, advice charges, administration charges and other charges — such as the cost of a guarantee or a penalty for leaving early — added into a single yearly figure.

It is shown for several holding periods, because an initial fee or an exit charge weighs more heavily when spread over only a few years. The EAC is an estimate built on standard assumptions, not an exact bill; its purpose is a like-for-like comparison, and you can ask to see it before you invest.

Why a small difference compounds

A yearly fee that looks tiny on paper is easy to wave away. But it is charged every year, on the full value of the investment — including everything that investment has grown by so far.

Money that leaves as a fee cannot earn anything in the years that follow, and neither can the growth it would have produced — compounding working in reverse. Over a few years the gap between a lower-cost and a higher-cost version of much the same investment tends to be modest. Over the decades that retirement saving can span, it may become a meaningful share of the final amount.

We quote no figures because the outcome depends on the returns, the term and the fees involved; an adviser can illustrate it with your own numbers. Returns are uncertain, while fees are far more predictable, so a higher fee generally has to be earned back before you are better off.

Cheaper is not automatically better

None of this means the lowest cost is always the right choice. A fee is only one side of a comparison:

• What the investment holds. An index-tracking fund and an actively managed fund spread across several asset classes do different jobs. Compare like with like.
• What you get for the fee. Advice that helps you stay invested through a difficult market, or that prevents one expensive mistake, may be worth more than it costs.
• What reaches you after all costs. What counts is the return after every fee, for the risk taken — and past performance is not a guide to the future.

The reverse also holds: a high fee is no sign of quality. The useful question is always the same — what am I paying, and what am I getting for it?

How VyroPlus helps

VyroPlus is an authorised Financial Services Provider based in Kimberley, and investments are one of the eight areas we help with. Costs are part of the conversation from the start, which usually covers:

• every layer of cost — fund, platform and advice — set out clearly before you decide anything;
• the effective annual cost disclosure for whatever is being considered, in plain terms;
• how any advice fee would work, and what service it is meant to pay for;
• what you already hold, what it costs and what changing it would involve.

There is no obligation, and no return is ever guaranteed. The aim is that you understand what you are paying and why.

Questions to ask

Before you invest, it helps to have answers to these:

• What is the effective annual cost?Ask for the disclosure in writing and look at more than one holding period. When a fee is quoted to you separately, ask whether the figure includes VAT.
• What are the fund’s TER and transaction costs?Both are on the minimum disclosure document — and ask whether there is a performance fee.
• Is there a platform or administration fee?How it is charged, and whether the rate changes as the amount grows.
• What advice fees am I agreeing to?The initial fee, the ongoing fee and the service the ongoing fee pays for.
• What would it cost to change my mind?Exit charges, penalties on older contracts and any tax that a switch or withdrawal may trigger.