CAPE TOWN – In this advice column Carl van der Berg from Alexander Forbes answers a question from a reader who is worried about how much to put away for retirement and how much it should cost.

Q: I am 41 years old, with 24 years until retirement. I have a pension fund with my employer and also have a retirement annuity (RA) to which I contribute R2 000 per month.

The current value of my RA is approximately R785 000 and is invested in “PSG Moderate Fund of Funds – Class A”. I am looking for an independent view as to whether or not this is a wise investment and if I am investing enough. My current gross salary is R107 000 per month.

Also I am paying 0.7% admin fee per annum on my RA. Is this an acceptable percentage? What it boils down to is that approximately R420 is deducted per month hence my R2 000 monthly premium becomes only R1 580 per month.

What can I invest in for the medium term (kids education, new car, etc…) to generate maximum yield?

How much would I be investing and what would the level of risk be?

When considering your retirement plan, it is important to have all the relevant information. The key variables, outside of your current investments, that need to be identified are:

1. Your term to retirement. Time is either your best friend when you have a lot of it, or the opposite when you don’t.
2. Your income need. The higher your required income, the more your retirement funds will need to grow to accommodate this need.

A lot of emphasis is placed on an investor’s ‘risk profile’ in financial planning nowadays. In my opinion, however, this is sometimes given too much attention. A structured portfolio should look at investment term as its primary point of departure, followed by an accurate analysis of an individual’s need to take risk.

Looking at your current retirement planning, I would suggest that it may make more sense to look at what options exist for you to make contributions to your company pension fund rather than an independent RA. Institutionally-based investments typically carry lower charges due to having economies of scale.

Even though you might have reduced flexibility and fewer investment options in this fund, over a period of more than 20 years it should stand you in very good stead as a basic retirement blueprint.

As a rough guide, a person starting their career should be looking to contribute a minimum of 20% of their earnings to their retirement planning. Since your career started a number of years ago this figure may need to be higher. It would be worthwhile consulting a skilled adviser who can assist you to calculate the amount you should be putting away to reach your required goals.

I think it is also very important to talk about the murky and often confusing world of fees. My hope is that anyone who reads the next few paragraphs critically will be empowered in future conversations with service providers to ask the right questions.

In an investment such as an RA you would typically be paying three layers of fees. They may not all apply in your case, but in most situations where you have worked through an advice channel, they will. Each level is discussed below:

1. Administration fees:

These are the charges levied by the service provider for services such as their online platform, issuing tax certificates, call centre etc. The annual fee for this service would usually be between 0.15% and 0.3% per annum. As the fund balance grows, usually this fee adjusts downwards.

2. Advice fees:

If working through a financial adviser, then two kinds of fees could apply – upfront and ongoing.

When buying an RA through an insurance company, there there is a contractual agreement that you will pay a set contribution over a set number of years. This allows the insurance company to pay the sales agent the upfront fee directly and recoup this from you over the lifetime of the contract. This is why RAs offered by an insurance companies will often charge transfer penalties, or revise your balance downwards if you are unable to meet your monthly payments.

Be very careful about tying yourself into such an arrangement. An RA is already a very restrictive product when it comes to when and how you are able to access the maturity amount. Adding further restrictions to the contract is neither necessary nor fair.

What you really should be looking for is an RA that operates directly on a platform and is not sold as a contract. You might still have to pay an upfront fee, but this will be levied on each contribution made. Should the contributions cease so will the fee, without any risk to your investment balance.

Assuming the negotiated upfront fee between you and your adviser is 1%, then 1% of each contribution will be allocated to your adviser. On a R2 000 contribution this would be R20, or R22.80 with VAT included.

In addition to this upfront fee, your adviser might have an ongoing service level agreement in place to offer you ongoing advice services. At a minimum these should include an annual assessment of your investment as it relates to your ongoing financial planning and changing circumstances.

This would be an annual amount that could range anywhere between 0.5% and 1% of the invested assets. Let’s take a figure in the middle of this range of 0.75% (or 0.86% incl VAT). This would not reduce the monthly contribution into the fund, but would be levied against its capital.

If your investment value was R785 000 then the ongoing advice fee could be as high as R6 750 per annum at the 0.86% level. Monthly this would be R562.50, and could then make you feel as though your R2 000 per month is being reduced by this fee – this is however not true.

However, if you are paying this fee you need to be convinced that the level of your financial planning warrants these ongoing charges. In a rather straightforward contract such as an RA, you would need to be getting a very high level of service from your advisor, which would hopefully not be limited to this single investment, but should also deal with your estate and personal risk planning.

3. Fund manager fees:

Lastly, you will be paying a fund manager fee to the investment experts who make the trading decisions. All elements relating to this fee can be found in the Total Expense Ratio of the fund (TER).

These fees can vary significantly depending on the nature of the investment fund, and also on its performance. A money market fund might have a very low TER of 0.6% per annum as such a fund does not incur high levels of costs, while multi-asset funds show fees that are typically much higher.

If the fund manager fee is paid through cancelling some of your investment units, the only two charges that you should see on an investment statement would be administration and advice charges. Your ongoing contribution would be reduced by the upfront advice charge (even after many years in the investment) and this should be the only fee levied directly against the contribution made.

In other words if the upfront fee was 1%, then the net amount going into the fund would be R1 977.20. If the ongoing advice and administration charges come to 0.75% and 0.2% respectively, then because these fees are levied against the total capital value of the fund, you would be losing 1.083% of your fund value per annum to pay these fees.

It is imperative that your consider your performance expectations in light of these fees. For instance, if you previously required returns of inflation +5% to meet your planning need, you now look to achieve inflation +6% to compensate.

In terms of the investment structure of your current RA, the investment space for retirement products is regulated, and the restrictions apply to how much can be invested in different asset classes such as equity, property and offshore exposure. Typically an RA is a long term investment, and since you are planning on staying invested for 24 years, I would encourage you to consider using managers who offer high equity exposure. Over the long term, inflation is your biggest enemy, and you have to trust the asset classes that have shown their worth in overcoming it such as equity and property without worrying about their volatility.

Lastly, in terms of question about a medium-term investment, if you are looking at a term of over five years then I would suggest that a similar balanced fund approach would be acceptable. Anything less than this, and I would encourage you to rather reduce your volatility risk. The last problem you want to deal with is needing funds, but having them undervalued at the time that they are required as the markets have pulled back at that moment.

In these situations, knowledge is power, and like with any service that you pay for, you are the consumer in a competitive market. Make sure that you do comparative research, and make sure that whoever you are trusting for very important and sometimes technical advice is able to offer you a competitive solution, not simply because they are very convincing, but because they can show you the numbers.

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