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Monday 18 June 2018

Is 86c Expensive?

Who remembers these?
A while back I listed the ETF’s with the highest Total Expense Ratios (TER) in a post on my Facebook page. The most expensive one came in with a TER of 0.86%.

Someone commented on the post asking what a TER was, and so I explained the concept and used an example which equated to saying you pay around 86c per R100 you have invested every year. Someone else then commented saying that that is really not bad if we consider that to be expensive.

I quickly realised that, yes, if you look at it that way, 86c per R100 over a year seems pretty insignificant. To put it another way, R8.60 on a R1000 seems hardly noticeable. In fact even a 2% fee (R20 per year on a R1000 investment) seems dirt cheap at less than R2 a month.

But the problem is that we shouldn’t be viewing this in isolation over a 1 year period. Maybe that is why people are generally happy to sign up for products with fees which total well over 2%. I guess they think that R2 per R100 is peanuts. Is that really that much worse than paying R1 per R100, or 50c per R100 in fees?

What’s important to realise though, is that equity investments can (and should) be held for multiple decades (especially retirement investments) in order to reduce risk and maximise returns. As this long time period plays out, the investment grows ever larger, and those small rands of fees turn into bigger rands, which compound month in and month out, eventually turning 86c into a couple of rands, which quickly turns into 10’s of rands, 100’s of rands and ultimately thousands of rands.

Consider R100/month investment growing at 15% over 15 years. What does a TER of 0.86% mean then?

Well, at the end of the period you would be left with a little over R56k. Total fees paid = R2,537.

But hang on, even over such a long time period, that averages out to around R14 a month – that’s not too bad?

Even Champ Kind knows about the
double whammy of fees!
But here is where the double whammy of fees comes in.

You see the fees that are paid not only reduces your balance by the amount of the fee, but you also lose out on all the growth that the money that went towards fees would have had.

So although you paid a total of R2,537 in fees, the lost growth on that money means you end up with R5,020 less than you would have without the fees. The actual value of the fee is only half of the total amount you lost out on!

That small little 0.86% fee stopped your investment from growing another 9%.

But perhaps the scariest way of looking at it is that the R5,020 is equal to 50 months of your contributions. In other words, for the first 4 years and 2 months, every single cent of your investment went towards fees. Imagine paying a monthly contribution for over 4 years (you would know the 2018 and 2022 World Cup winners by then!) and getting nothing for it?

When you look at it that way, 0.86% does seem pricey, especially when you consider that some of the 0.86% TER products I listed in the Facebook post are available from other providers at a mere 0.2%. With a 0.2% TER, the same R100/month scenario will see you paying total fees of R619, and your investment is worth only 2% less than it would have been without fees. (Of course we would still want fees even lower, but this is about as cheap as it gets in South Africa.)

The table below summarises the results for a R100 investment growing at 15% per annum for 15 years.

No Annual Fee
0.2% Annual Fee
0.86% Annual Fee
Total Fee Paid
Final Investment Value
Amount lost to fees

And finally, consider someone maxing their Tax Free Savings account with R2,750 a month for 15 years with the investment growing at 15% per annum.. Paying a 0.86% fee leaves you a massive R104,720 worse off than a 0.2%, and R138,166 worse off than no fees!

No Annual Fee
0.2% Annual Fee
0.86% Annual Fee
Total Fees Paid
Final Investment Value
Amount Lost To Fees

So yes, 0.86% is expensive, very expensive.

Till next time, Stay Stealthy!
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