I often speak of getting the basics right when it comes to investing and how that can make a significant difference to your final net wealth position.

A common metaphor that captures this concept rather nicely is “picking the low hanging fruit”. In other words doing the small and easy things to tweak a portfolio or investment plan that involves little real effort to exact a meaningful change.

The reason I mention this metaphor is that I was having a conversation with someone who had recently completed an annual review with their advisor and was bouncing some of the proposed changes off of me.

Without going into any detail or giving away any personal information I thought I would share what I perceive to be a great example of how to pick some of that proverbial low hanging fruit.

The proposed strategy shift was going to involve moving some underperforming collective investments into a straight forward ETF or tracker fund – so far so good and it sounded sensible to me. Then he went on to say that the proposed investment tracker was going to be the Satrix 40. Without wanting to step on any toes I suggested that he should ask his advisor why he should not opt for the RMB Top 40 tracker instead. After all it was exactly the same product, with exactly the same underlying index , the only key difference was that the RMB fund charges less than half the annual fee that the Satrix product does. (0.19% TER for RMB versus 0.45% for Satrix*).

The advisors answer was surprising to me : “The products are the same, RMB is not going to do any better than Satrix and if it does then it will be marginal – So no, I do not think we should consider RMB.” He went on to illustrate his point by highlighting that the 1 year performance of the RMB fund was 25.32% versus Satrix at 24.94% – so a mere 0.38% difference and therefore insignificant.

We can do a quick ‘back of the envelope” assessment of why that statement is not only blatantly factually incorrect but also represents a costly missed opportunity for his client.

First mistake: The advisor was probably complacent about the fee amount because returns from the South African equity market have been phenomenal in the recent past. Admittedly 0.38% of 25% is only 1.52%. But what happens when equity market returns revert to their long term average of about 12.5% or even worse, the stellar performance in recent years (and the toppy current valuations), translate into lower single-digit returns in the years ahead?

It is hopefully clear from the table above that if the performance differential remains unchanged (as is likely given that it is almost entirely the result of different Total Expense Ratios between the funds) but the market return falls, then we will have gone from giving away a mere 1.5% of returns to almost 10% of your returns. Does this still sound ‘marginal’?

Second mistake: The advisor has seemingly forgotten about the concept of compounding. The annual differential of 0.38% may seem small at R3800 a year for a R1 million portfolio. But when compounded over 10 years* the impact on the final value of the investment portfolio will look something like this.

Yes, that’s a difference of almost R 75000 over the 10 year period. Still marginal?

In my mind that is at least a year’s worth of private school education fees for my little boy right there…. not marginal at all. Also, it is worth noting that over time periods longer than 10 years this number will only get bigger.

Third obvious mistake: The financial advisor is probably charging the client a fee of at least 0.5% a year, on the value of the overall portfolio. So the 0.38% performance differential between the two funds equates to about three-quarters of the advisors overall fee. If I was going to offer a 75% discount on my annual fee I’d hope that you did not consider that to be marginal? In fact you are clearly almost getting free advice as RMB is subsidising your advice fee to a large extent.

I am not in the habit of criticising other advisors as there is rarely ever only one right answer when it comes to investment planning. There are however certain things which are not open for interpretation or debate and in my mind this advisor’s conclusion is not only incorrect but it is short-sighted, uninformed and inefficient. A tracker fund by definition is going to deliver the index performance less fees – so in truth the RMB product is likley to ALWAYS deliver better performance than Satrix as long as the current TER differential remains. 

This client deserves better and we at White Investments will always strive to provide the best solution no matter how seemingly insignificant the marginal benefit of the low hanging fruit may initially appear. We understand that over time these small incremental differences can stack up meaningfully. 

*Source: the respective fund factsheets from the product providers as at 31.03.14
**The portfolio value assumes an initial investment of R1 million, earning 12.5% per year, with advisor fees of 0.5% and a platform fee of 0.7%.

If you have any questions or want further advice on how to structure your investments or improve your personal finances please contact us at info@whiteinvestments.co.za