There’s an old saying about the watched pot never boiling, which simply means that if you wait anxiously for something to happen, it seems like it takes forever. Continue reading The watched pot…
Over the years as we have chatted to clients about financial planning we have settled down to the “big 5” risks that everyone faces and the resulting financial (and emotional) risks that they present to the person and their family. Simply put, these are (in no order of importance):
- Dying too soon
- Living too long
- Funds for emergencies, and
A lot of the work that we have done with clients has been around identifying these potential risks and then implementing strategies to address them.
However, I have recently become convinced that there is a much greater risk that people face but that is hardly ever spoken about. I also think that this risk is likely to increase as the process of disintermediation increases.
Rightly or wrongly, Albert Einstein is often credited with saying that compound interest is the greatest force in the universe (or the 8th wonder of the world, or some other version thereof). And indeed, compounding is a significant force but I have become convinced that another scientist, Sir Isaac Newton, had much more to add to the debate.
Indeed, the “biggest” force that haunts people is to be found in Newton’s First Law of motion (you should have paid attention during science lessons). Newton One states that “a body will continue in its present state of rest (or motion) unless acted on by an UNBALANCED external force.” This is known as the rule of Inertia…or the tendency to do nothing or remain unchanged.
Simply put, we are all subject to Inertia and will continue to do the same things over and over unless we come into contact with an unbalanced external force. And that’s why people have personal trainers to hold them accountable to exercise and get them fit, that’s why we have seen an increase in the demand for life coaches and it is also the role of the financial planner.
Don’t get me wrong, I have no issue with people doing their own financial planning and/or investing. The problem is that they don’t! How else do you explain the father of 2 young kids who has no will 10 years after they were born, or the divorcee who has not changed beneficiaries on her life policy (or updated her will) or the employee who has not yet started saving, or the entrepreneur who has never submitted a tax return? I could go on…
The cold hard truth is that we are often our own worst enemies when it comes to things financial and it is my strong opinion that we all need an unbalanced external force in our lives to get us out of our inertia. As long as Newton’s First Law of motion holds, there will always be work for financial planners and for that I am very grateful! We have an incredible privilege as we help clients identify and manage their financial risks and then keep them accountable to address them.
Today I got a call from a journalist asking a few questions about what a beginner investor should do if they want to start investing. I think that they were looking for “tips and tricks” about which funds or shares to choose. Here was my reply. Continue reading The ultimate savings & investment vehicle!
I attended a presentation by one of the SA asset managers recently…it was a good job that there were no sharp knives around. It was real slit-your-wrists stuff!
Their view is that SA is pretty much stuffed and that unless there is a significant change in ANC leadership that we are on the “low road” scenario. The reasoning is as follows:
- SA stuck is in a no growth-low inflation scenario. The only reason the Reserve bank is not cutting interest rates is due to political risk fallout.
- The global search for yield has kept the ZAR strong (for now) – they see it considerably weaker over 3 years, especially if we get the Moodys’ downgrade on local debt (it seems inevitable at this stage).
- SA consumers are very stressed with much higher than normal variance in the payday compared to mid-month purchasing patterns (there is a massive spike at pay-day compared to mid month and this is much higher than normal). In addition to this, people are switching away from brand names to “no-name” products.
- SA food retailers have noted significant change in the composition of the average food basket – food inflation as measured by retailers is very different compared to what is measured by Stats SA.
- One of the SA retailers reported that for every R100 they are lending consumers, there is an additional R1700 in unsecured credit! Unsecured credit demand has increased radically.
- Another SA retailer has reported worst figures in 20 years.
- There are 17million people on social grants and this number is increasing rapidly…government is running out of money to fund this.
- SA facing poor consumer confidence (reduced spending), poor business confidence (reduced investment in SA) and poor employment numbers.
- The revenue (tax) base is shrinking, SARS is missing money due to incompetence.
- SARS (and treasury) have been haemorrhaging skills and there is a significant loss of expertise at both organisations.
- Tax payer non-compliance has increased as a result (and will continue to increase) thus worsening government revenue.
- Government is going to be desperately short of funds!
- The risk of a return to “prescribed assets” for pension funds has increased and along with this a limit on moving funds offshore and possible cancelling of asset swap capacity for local funds!
It’s a good job that there were no sharp knives around…having said this though, they are still positive medium-to-long term IF the Zuma faction is outed from government.
Much has been written about the value of financial advice. There are many people who believe that financial planners offer little value for the fees charged while there are others who believe that the value financial planners add is very significant.
Research by Morningstar has revealed that the value of advice (they call it “gamma”) can be as much as 3% (of the client’s portfolio) per annum. This is, among other things, a result of managing investor behaviour and greater tax efficiency for the advised client.
We have more than a few clients who prefer to manage their own funds with no on-going advice fees and who will then consult with us from time to time when they think it necessary. And while this may seem to save them an “annual advice fee”, in my experience, it has almost always cost them significantly more than the fee that they would have paid as an “advised” client. Consider the following example from our practice.
The client retired a few years back and transferred his funds to a living annuity – he met with us around the income draw, asset allocation and resulting fund selection and has been looking after it on his own since then. He has been drawing the minimum income (as a result of some consulting that he was doing) until the anniversary earlier this year when the consulting stopped and he needed to increase the annuity. Which he did – without consulting us and without any thought to the tax consequences.
He did not consider that he had a discretionary pot of money from which he could effectively draw (close to) tax-free income. The result is that he is now paying at least R100k in tax that he need not be paying. This is R100k that we would have saved him if he had been an advised client (or if he had at very least sought advice before making the change). The R100k is certainly many times the quantum of the annual fee that we would have been paying. And he is currently staring at an estate duty problem because of the choice to increase the annuity income draw and leave the discretionary assets in his estate.
Add to this the fact that he recently switched funds – “the funds had done nothing for the past few years” and so he made the change. The move was at exactly the wrong time and his asset allocation is now also out of kilter (way too much offshore exposure for a living annuity with a 5% draw). The annual fund fees that he is paying is also way too high – he had “no idea that was an issue”.
Clearly in this case, the value of advice would have been way less than the cost to his portfolio. But then, perhaps we have ourselves to blame. If all clients think we do is choose funds then why would you pay (a significant) ongoing fee for that?
We need to make sure that clients fully understand that asset allocation is but one part of the value-add from a professional financial planning service. There is so much more to the financial planning service, but they wont know that if we don’t tell them and more importantly, if we don’t demonstrate it.
On a recent car trip, my daughter insisted on playing some of her music – 2 of the songs on the “hit list” were “Bear necessities” from the Jungle Book and “Hakuna Matata” from The Lion King. When the music finished there was a follow up question from her to me – “what’s your favourite Disney movie, dad?”
I thought about it and decided that “Disney” could now include Pixar and went with “The Incredibles” followed by “Monsters Inc”. And then I asked her. “Jungle book, followed by Lion King” was her reply. Her younger brother concurred.
As I pondered this I realised I had just witnessed a case of what behavioural economists call “anchoring” in practice. In short, anchoring can be described as the human behaviour trait that gives more importance to recent history than to things that happened long ago. This tends to skew our view of things…we all do it and we all need to be aware of it, especially when it comes to our money. For a more precise definition read the bit below by the people that first described the concept, Nobel prize winners Amos Tversky and Daniel Kahneman.
“Anchoring is a particular form of priming effect whereby initial exposure to a number serves as a reference point and influences subsequent judgments about value. The process usually occurs without our awareness (Tversky & Kahneman, 1974), and sometimes it occurs when people’s price perceptions are influenced by reference points. For example, the price of the first house shown to us by an estate agent may serve as an anchor and influence perceptions of houses subsequently presented to us (as relatively cheap or expensive). These effects have also been shown in consumer behavior whereby not only explicit slogans to buy more (e.g. “Buy 18 Snickers bars for your freezer”), but also purchase quantity limits (e.g. “limit of 12 per person”) or ‘expansion anchors’ (e.g. “101 uses!”) can increase purchase quantities (Wansink, Kent, & Hoch, 1998).” https://www.behavioraleconomics.com/mini-encyclopedia-of-be/anchoring-heuristic/
I found myself facing a crisis recently. I have always promised clients that I would only invest their funds where I myself am prepared to invest for myself and my family and yet with the recent shenanigans from our president who saw fit to remove the finance minister, I found myself at a cross roads. From my very simplistic point of view, South Africa is facing one of two future outcomes:
- We are either at the point where Zimbabwe was 20-25 years ago, or
- We are facing a short-to-medium term of economic pain (5+ years) from which we will ultimately emerge.
The crisis for me is that if I believe that we are a future Zimbabwe then it requires action now, 10 years’ time will be too late. At the very least it would require financial emigration which would involve selling our house, taking the capital offshore and then renting. On top of that it would mean no longer contributing to retirement funds in SA. That’s a radical departure and advice of that nature could be considered reckless at the least. But it would be what I am doing and it would require telling my clients about the path of action that I have taken.
On the other hand, if I believe that our crisis is going to be short-to-medium term but that we will ultimately emerge then we can stay in SA, keep the house and still continue to make use of retirement funds here. That does not mean to say that regulations around retirement funds wont change (think prescribed assets and the withdrawing of asset swap facilities). If that happens then we adjust at that stage, but for now we continue. In addition to continuing to contribute to retirement funds in SA, it makes sense (from more than a fear point of view) to continue to invest discretionary funds outside of SA via the annual discretionary allowance. It’s a big wide world out there and if you sat on the moon and looked at the earth as an investment destination, you would not put 99% of your money into the very small economy at the tip of Africa. Diversify!
So with these two scenarios in mind I went looking for some answers. The problem is that there are few people who you can ask and who will give an honest answer. There are too many conflicts of interest. Pension fund managers’ incomes are a function of people investing in their products, so too for asset managers and there are few economists who are prepared to be quoted as saying that SA is a complete basket case and that it’s time to get out before it is too late. Yes, there are some “journalists” and commentators who have written about the doom filled future but their articles are too sensationalist, emotive and lacking in substance for me.
I finally managed to have a few off the record chats with some asset managers and strategists and last week I resolved the issue for myself.
I truly believe that we will emerge from the crisis that we are facing as a country. It’s going to be tough in the short term, even if Zuma is removed. There is still a lot that is rotten in Government and our State-Owned Enterprises and this is not going to change overnight. We are also facing an increasingly divided society with yet another generation of poorly educated youth. These are significant challenges that face us.
But there are brave, principled people who are finally starting to take a stand against the blatant and unashamed looting of state resources and our country. These are the future leaders of this beautiful land and this is one of the reasons that I have hope and am not selling my house. I will contribute to my pension fund this year and I will continue to diversify any surplus investments offshore. I also commit myself to building a fairer, less divided country for all. For now, “normal” service has resumed.
I have just finished reading this excellent book by Carl Richards…
The One-page Financial Plan – some notes from the book:
“The best financial plan has nothing to do with what the markets are doing, nothing to do with what your real estate agent is telling you, nothing to do with the hot stock your brother-in-law told you about. It has everything to do with what’s most important to you.” p7
• know why you are planning
• time spent + money spent = what you really value.
• it’s about making best guesses (and not obsessing about getting things exactly right) – a lot can happen between now and the future!
• It’s about giving yourself more time!
• Things you have to invest: money, time, energy and skills – all NB to consider
• Most people don’t have a clear understanding of their current financial situation. Budgeting = awareness
• budgeting & flossing: both insanely important, super simple, & for many of us, nonstarters
• save as much as you can
• spend less than you earn
• don’t lose money
• life insurance plays 1 role: it covers economic loss. It is an expense, not an investment…it’s about the risks you are ok with and the risks you’d like someone else to take care of. Economic need, not emotional loss.
• Paying off debt = investment with guaranteed return
• Speculation and intuition are not investment strategies
• Invest and then behave for a really long time
I just came across a client who has been sold a decreasing life annuity by someone representing Liberty Life. Yes, I know that there is no such thing (officially) as a decreasing life annuity (no one would buy it if there was) but this is effectively what a non-escalating life annuity is. You have condemned the client to future poverty!
While the initial income may look more attractive, in 20 years time (the guarantee period on the annuity for a 65 year old with stage 3 cancer and no financial dependents?) she will be getting an income which will be less than 1/2 of what she should be getting if there was an inflation linked escalation.
This is the kind of product and advice that gives our industry a bad name. If the insurance companies and ASISA wont act then perhaps it is time that the regulators banned this kind of product.
One of the frequent tasks we face for clients is something known as a Section 14 transfer – this involves moving a retirement annuity (or preservation fund) from one company to another. Typically this would be from an insurance company to a unit trust company. Reasons for clients wanting to do this are many, such as:
- No/limited transparency from the insurance companies with respect to costs and performance of their investments. Many investors suspect that the fees are high and performance is poor but they are horrified when they find out the actual figures. The high fees are not limited to the “old generation” RA’s – there are many “new generation” products with very high annual fees! Investors should stay away from any investment via an insurance company…there are better options elsewhere – let the insurers focus on insurance!
- No/limited flexibility when it comes to making changes to the contribution amount or term and did we mention the penalties that are frequently applied to anyone wanting to move their funds? This is a legacy to an archaic pricing model. People’s circumstances change, often through no fault of theirs and to penalise someone who can no longer afford to pay a premium as a result of being retrenched or being forced to join a work pension fund is immoral and a bad business practice. There are better ways to do business!
So, to any of the insurers out there, here is the message from consumers. There is something fundamentally wrong with the business model when the S14 dept is “understaffed and backlogged” to quote one of the employees. The longer you take to action S14 transfers (180 days is the “legal max and many of you are abusing this) the more the reputation of your company is damaged. This applies to all the insurers – you may think you are keeping the funds for longer and making it difficult for people to transfer and that as a result they might eventually give up in frustration, but the reality is that in the process you are losing clients forever.
Address the issues that are leading to so many clients wanting to move – and it’s not advisors chasing commissions! Rather, it is a fatally flawed business model that is constantly dependent on new business to survive.