No fees, commissions – but at a price!

No fees, commissions…but at a price!

RSA Retail Bonds are quite popular among the investing public, and especially amongst older people desperate for income. On the face of it, the yield is quite attractive, especially when compared to money market rates (the 2 year yield on the RSA is currently 6% compared to around 4.5% from most money market funds) and according to the website, there is “no risk”.

So when Joe Public, who already has a jaundiced view of the financial advising community, hears the advertising line “no charges, commissions or costs”, it seems like a no-brainer. Cut out the advice component and get a better deal…or will you?

If it is income you are wanting, then it the RSA Retail Bond is not a bad option – the current rates on the RSA Retail Bond are as follows:

So investing R1million would give you an income of R70000 pa (fixed for 5 years) and at the end of the term you will get your capital back.

Problem is though; your R1million is no longer worth R1million. It is worth significantly less and you did in fact, despite the claim to the contrary, take risk on the capital; inflation risk! And as a result, assuming an inflation rate of 6% pa over the period, your R1million would only be worth around R740000 after the 5 year period! So while the RSA Retail Bonds might appear reasonably attractive from an income point of view, your capital is at risk! The same can be said for the “guaranteed” term certain annuities that many companies offer.

So are there any real alternates? Yes, I think that the “enhanced income” unit trust fund space is a very real and attractive alternative to those investors looking for income and the possibility of some capital growth.

Consider the following: 5 years ago (Sept 2007) the RSA Retail 5 year yield was 8.75% so if you had invested R1million into the 5 year option you would have received an income of R87500 per year (fixed for 5 years) and you would have got your (R1million) capital back at the end of September 2012.

If you had used the Coronation Strategic Income Fund*, for example, over the past 5 years and had drawn the same income from the fund (as the RSA Bond) your capital at the end of the September 2012 would have been worth around R1.075million…still behind inflation over the period but at least there was some capital growth! In fact, you could even have drawn an inflation linked escalating income over the 5 years and then still got more than R1million back (R1.010m to be precise). But then, how would you know this if you bought the by-line that no fees, costs or commissions meant that you were automatically getting a better deal?

If I was currently looking for income from my investments I would most certainly consider the “enhanced income fund” space but there need to be a few warnings before doing this.

• Every investment carries some form of risk – even if you just leave the cash under your mattress you are taking at least 3 significant risks; theft, fire and inflation.
• In the same way there is risk in “enhanced income” funds – make sure that you understand what these are before you invest (as a rule there is little or no equity risk – the risk comes from interest rates and credit default).
• Over periods of 12 months and more this risk is very low (because of how the funds can invest) but make sure you do your homework first!
• Make sure you have a realistic expectation of the kind of income you can get from your capital – cash rates are currently around 4.5% and it would be reasonable to expect around 6.5-7% pa from these funds – but this is not a guarantee (it could be more and it could be less). So temper your income draw – if you are going to draw more than this then there is a very real chance that you could eat into your capital over time.
• Any money invested into these funds is not locked in for any period and you can access some or all of the capital at any stage.

What the regulators, companies and the general public need to realise is that “no fees or commissions” is not the panacea that it appears to be – investors would generally be better off paying for good objective advice rather than rushing into options that appear to be cheaper but that could cost more in the long run.  And by the way, if you use a financial planner and pay her a fee, you could access these funds at no initial fees!

Notes:*the writer does not work for or get paid by Coronation and the Strategic Income Fund was not the top performing fund over the past 5 years either, but it has been a consistent performer in this space.