This is just wrong!!!

I came across a 76 year old lady this morning who was sold a 10 year endowment at the age of 71 (through Old Mutual Horizons) for R10000 per month (yes, ten thousand rand!). 5 years later her situation has changed, she cant afford the premium anymore and needs to make a change…surprise, surprise, she is going to receive huge penalties for doing this.stealing_3673

This is just wrong and I dont care how anyone might try to justify this, there is no reason that this should have happened and the company should never have accepted a 10 year term when a 5 year term would have achieved the same goal.

There is, unfortunately, only 1 reason that a 10 year term was taken – fees and commission. Under the “new” commission regulations (which are the only ones I can get to generate a quote) a 5 year term would earn the broker R28000 in commission and a 10 year term would generate R52800 in commission. The company admin fees would not be that different from these figures so it is not hard to see why the broker made the term 10 years and why the internal compliance officer at the company could not see any “issue” with the case. This is just theft! and it is the kind of thing that continues to give our industry a bad name.

If the term was 5 years she could have had access to her funds and could always extended the policy on an as-and-when basis…better still, she could have been in unit trusts where there are never any penalties (but the commission is much lower and takes longer to earn).

Stay away from insurance companies if you want to invest money!

Gregg

Medical aid or glorified hospital insurance?

medical_bag2There was a lot of information about medical aids in the weekend press, a lot of it was very critical of the many schemes. While some of it is certainly warranted, what most people dont seem to grasp is that while many of us think that we are members of a medical aid, we are actually just members of glorified hospital insurance schemes. And even then, not all our “in hospital” expenses will be covered by the schemes.

Once we make peace with this fact, we will start to understand what is and what is not covered. We have opted for the plan which is just above the basic plan with Discovery and have been on it for more than 10 years now. We understand that all of our day-to-day medical expenses and even some of our in-hospital expenses will be for our own pockets. Other than that, the scheme covers just about everything (at 200% of medical aid rates) and to be fair to them, when we have claimed, they have paid. So there is no disappointment when they dont pay for things – we knew all along that this was the plan that we had chosen – we dont have a medical aid, we have hospital insurance.

Nor do we make use of their savings plan – I know that there are some advantages to it, especially if you use their network of prescribed doctors. But the kid’s doctor is not part of their scheme and is not likely to be any time soon. So, we put away funds each month into a money market unit trust account to cover those “day-to-day” expenses and I know that we get a much better interest rate on our money in the money market than any medical scheme pays on the savings account. At the end of the day, whether the money comes from the savings account at the medical scheme or from our money market account, it is all money that we have had to pay in and I would rather earn a decent interest rate and have full control over the funds than not know what I am earning and also not be able to use the funds as we want/need.

Perhaps the most interesting bit of information that I picked up was that a family of 4 would need at least R20000 in discretionary funds to pay for their out of hospital expenses – that’s a significant sum of money and certainly puts healthcare out of reach for most people in SA. Clearly there is a need for national health insurance of some sort!

Be wary of 1life direct’s advertising campaign…

1life610

Saw the TV advert for 1life direct recently…watch out, the cover they are offering is incredibly expensive. Far from cutting out the middle man and therefore being cheaper, it is significantly more expensive than you could get even if you went through a broker who was charging full commission.

For example: A quote from 1life direct (with no commission) is as follows:

Policy Information
Product: 1Life Elevated
Life Cover Amount: R 1,000,000.00
Term of Policy: Whole life
Total Monthly Premium R 322.99

The same amount of cover through another insurance company, with full commission on it would cost me R183 per month. Far from being “22% cheaper by cutting out the middle man”, 1lifedirect is in fact about 77% more expensive. Now if we remove the commission from the quote then the premium for R1million life cover for me would be R138 per month and 1life direct are about 135% more expensive.

As I have said before, watch out for insurance companies and dont underestimate the value of good, independent financial advice.

That’s all for now

Gregg

Rocket science or common sense?

For Sale Sign

One of the things that I just cant get my head around is the price of residential property. If the experts are to be believed, then the average house price in SA is somewhere around R550000. In order to buy this property, you would need to put down a deposit of at least R110000 (20%) and would then have to pay off a bond of R440000. With the prime rate at 11% and assuming you could get 0.5% below prime (not nearly as easy as it used to be) then this would leave you with a monthly repayment of just under R4400 (R4393). In order to qualify for this bond you would need to have a combined monthly household income of ±R14500 per month.

Here in lies the problem: the average salary in South Africa does not even come close to this amount. According to Finscope 2008, the average household monthly income in SA is ±R5750 (R10000pm in Joburg and ±R6400 in CT). So how do Mr and Mrs Average buy the average house? They cant!

So who is buying all the houses and why would they do this?

Conventional wisdom states that you cant go wrong with buying residential property as an investment. Currently a R500000 house might realise a rental income of ±R3000 per month (before commission, rates etc). If we assume a net income of R2500 after expenses then this equates to a rental yield of ±6% per annum. This is not a great yield and seems to decline even more as the value of the property increases. In fact, rental yields have not been good for quite a long time now.

If I took my R500000 and put it in the money market, I would get a yield of ±8% at this stage so the rental yield is not that attractive (in both cases these are pre-tax yields).

So why would I buy the property?

Capital growth of course! After all, property only goes up over time! Apparently this is not a given and as property prices have fallen over the past 2 years not only have people seen their values decline but many people are also sitting with negative equity on their properties (i.e. they owe more on the property than it is worth and in many cases the rental income does not even come close to the bond repayment).

Now my problem is this: if Mr and Mrs Average cant afford the average house (because they don’t earn enough) and as a result they need to rent, how are they going to be able to afford increased rentals either? As I see it, they cant afford to buy their own place (prices are too high) but neither can they afford to subsidise someone else’s retirement plan and desire for rental yield and so either rental yields will have to stay low (and you should rather use the money market for income) or else property prices have to fall (and you should stay far away from this).  Why take good money and stick it into an investment property with a poor yield and little prospect for growth?

If you are seriously thinking about buying a property to rent it out then my advice would be to be patient, something’s got to give.

That’s all for now!

The Financial Coach™

Commission free life cover…

thumbnailCA5TPCTEAs a follow up to the post on cutting out the middle man, I thought I would write about another case of “half-truths” from insurance companies.

About 6 years ago, I was at a financial planning conference where the issue of fees and commissions was being discussed by a panel. One of the panel members was representing the LOA (Life Offices Association, now ASISA) and he stated that about 35% of the cost of new business for life insurance companies was the cost of commission that they paid to advisors. This means for every R100 of premium, R35 was (according to the official industry association) a direct result of the commission that was paid to advisors.

Being the trusting type, I therefore assumed that if you remove the commission from the quote, there should be a reduction of ±35% in the cost of the cover. So for about 6 years now, we have been providing life cover for our clients without any commission on the policies*.

The problem is that in whole time that we have been providing commission free life insurance policies (yes it can be done), we have not yet seen a reduction even close to the supposed 35% that the LOA was touting, nor have we found anyone in the industry that has been willing or able to explain the reasons for the discrepancy.

For the record and in our experience, if we remove the commission from the life cover then there is a reduction of between 12 and 27% in the cost of the cover (depending on the insurer) this is clearly far short of the supposed 35% and some insurers are obviously creaming more for themselves than others.

In practise this means that if the cost of the cover (with full commission) would have been R1000 per month, by removing the commission from the policy, the premium could be reduced to ±R750 per month). Over a 10 year period that is a saving of at least R30000 in additional premiums. Makes you think, doesn’t it?

That’s all for now!

The Financial Coach™

*we do this by charging an hourly rate for work done in providing the cover – typically this is anything from 2-4 hours depending on the type of cover involved.

Sometimes cutting out the middleman just leaves a gaping hole!

images

I recently received a marketing offer from 1lifedirect to take out some life cover directly through them, thereby cutting out the paperwork, expensive medicals, the broker and therefore the commission. All of this, they promised, would save me up to 22% on the premiums.

Having seen their rather funny TV adverts and being the curious sort I decided to give them a call to see if things were as good as they promised. After all, their flyer offered me R500000 life cover for only R140 per month (subject to certain terms and conditions of course).

On the face it of their offer sounds quite attractive – but on further investigation it is anything but so. Some comparative quotes to see what I could get elsewhere revealed that I could get R896000 life cover for R128 per month (with full commission on the policy). The same cover without any commission on the policy would cost just R100 per month – now that is a saving of 28% on the full commission quote and is over 50% less than the 1lifedirect quote. So there really is no saving of anything and in fact, sometimes cutting out the middleman could turn out to be quite a bit more expensive.

The 1lifedirect offer is not nearly as good as it initially seemed and far from it being a quick and convenient process they could not give me a quote over the phone because of the fact that I do the occasional scuba dive. The quote needed to be done by their actuaries…7 working days later and still no quote from them despite 2 follow up phone calls from me. By this stage, the average insurance broker would have had the case finalized and issued and I don’t even have a quote. Sometimes going direct is certainly not a quicker or more convenient process.

1lifedirect also say that they cut out the need for expensive medicals – for the record, most medicals are paid for by the insurance company concerned. This is certainly the case where the insurance company is the one that calls for the medicals. Sometimes going direct can mean that you stay ignorant of the facts.

1lifedirect also claim that they cut out the need for paperwork. Far from this being a pro it could turn out to be a real negative the next time you apply for insurance cover; no paper work means that you have no record of what you answered on the medical questions and no record of answers significantly increases the risk of accidental non-disclosure. As a consequence this significantly increases the risk of a claim being repudiated by the insurance company (because of the accidental non-disclosure).

So, far from being “life insurance that is quick and convenient, and that – by cutting out the broker – saves you money!” in my case, the offer by 1lifedirect turns out to be significantly more expensive, not so quick and also potentially increases the risks when applying for future insurance.

For the record, I have no problem with people going direct. To me it is much like fixing the toilet at home – I can do it but it will take time and effort and I might not have the necessary tools. Either I invest the time and energy or I pay a plumber to do it for me.

In the same way, if a broker can’t add value to the client and he/she knows what they want and has the time to do it then there is no reason that they should not go direct.  They just need to be aware that it may not always be the best option and that while in some cases it may appear to be cheaper it could turn out to be a very costly exercise.

Sometimes cutting out the middle man just leaves a gaping hole.

That’s all for now.

It's not all in the name

Just read an article online about how in these tough times one of the positive outcomes is that people seem to be investing more into their retirement funds. The bad news, though, is that it is still usually too little to enable most people to retire financially secure.
Of bigger concern for me, however, is that not only are most people contributing too little, but on top of this, most people are probably not taking enough risk on their funds. This has mostly to do with the fact that most funds are completely inappropriately named or labelled.
For example, where there is individual fund choice within a pension fund, there are usually 3 or 4 funds such as the “Aggressive Fund”, the “Balanced Fund”, the “Conservative Fund” and possibly a guaranteed or money market fund. On seeing the word “Aggressive”, most investors usually panic and run for the relative safety of the Balanced or Conservative Fund (after all this is retirement money so they don’t want to risk it). Balanced Funds in this context will usually have ±50% in equities with the Conservative Funds having even less. Now we know that the best way to beat inflation (over time) is to have exposure to equities. So while they will probably not lose too much in the down cycle as a result of this choice, they will most probably also not benefit sufficiently in the up cycles.
The problem, you see, is in the names of the funds. Remember that in terms of the investment guidelines for retirement funds, you can never have more than 75% of the total fund invested in shares*…so how can that ever be an “Aggressive” fund? In the unit trust industry, funds with 75% in equities are usually referred to as Managed or Balanced Funds. So why the inconsistency in naming when it comes to pension funds?
As a result of this inconsistency, my suspicion is that not only are people not saving enough money for their retirement, but on top of this, they are also being too conservative with their fund choices and as a result of this they will have even less than they expected when they retire.
Bottom line is that if you have time on your side (at least 12-15 years before retirement) you should most probably be in the most “aggressive” portfolio that you can – this is the greatest chance you have of achieving inflation beating returns.
So remember, when it comes to retirement money, you can not, by definition, have an aggressive fund – at least 25% of the fund will be in cash, bonds and property at any stage.
That’s all for now.
The Financial Coach™
*yes, I know that technically speaking there could be up to 90% in shares and property, but the reality is that this is usually not the case, with most “aggressive” funds having 75% or less in equities with the balance in bonds and cash.

Just read an article online about how in these tough times one of the positive outcomes is that people seem to be investing more into their retirement funds. The bad news, though, is that it is still usually too little to enable most people to retire financially secure.

Of bigger concern for me, however, is that not only are most people contributing too little, but on top of this, most people are probably not taking enough risk on their funds. This has mostly to do with the fact that most funds are completely inappropriately named or labelled.

For example, where there is individual fund choice within a pension fund, there are usually 3 or 4 funds such as the “Aggressive Fund”, the “Balanced Fund”, the “Conservative Fund” and possibly a guaranteed or money market fund. On seeing the word “Aggressive”, most investors usually panic and run for the relative safety of the Balanced or Conservative Fund (after all this is retirement money so they don’t want to risk it). Balanced Funds in this context will usually have ±50% in equities with the Conservative Funds having even less. Now we know that the best way to beat inflation (over time) is to have exposure to equities. So while they will probably not lose too much in the down cycle as a result of this choice, they will most probably also not benefit sufficiently in the up cycles.

The problem, you see, is in the names of the funds. Remember that in terms of the investment guidelines for retirement funds, you can never have more than 75% of the total fund invested in shares*…so how can that ever be an “Aggressive” fund? In the unit trust industry, funds with 75% in equities are usually referred to as Managed or Balanced Funds. So why the inconsistency in naming when it comes to pension funds?

As a result of this inconsistency, my suspicion is that not only are people not saving enough money for their retirement, but on top of this, they are also being too conservative with their fund choices and as a result of this they will have even less than they expected when they retire.

Bottom line is that if you have time on your side (at least 12-15 years before retirement) you should most probably be in the most “aggressive” portfolio that you can – this is the greatest chance you have of achieving inflation beating returns.

So remember, when it comes to retirement money, you can not, by definition, have an aggressive fund – at least 25% of the fund will be in cash, bonds and property at any stage.

*yes, I know that technically speaking there could be up to 90% in shares and property, but the reality is that this is usually not the case, with most “aggressive” funds having 75% or less in equities with the balance in bonds and cash.

The future of the entire unit trust industry hangs in the balance.

The latest developments in the Ovation Curatorship saga potentially have major ramifications for the entire unit trust and linked product industry and it is high time that the industry (ASISA and the FSB) woke up to that fact.

As I understand the development, the Fidentia Curators are wanting to block the application by the Ovation Curators to release investors funds from Ovation (90% at this stage with the balance to be released once the process is complete). The Fidentia Curators believe that Ovation owed Fidentia money. But Ovation has no money and so the Fidentia Curators want to claim the money from Ovation Investor’s unit trust funds. And here in is the issue.

Unit trusts have always been marketed on the grounds that investors own units in a trust fund. The money in the trust fund is just that; in a trust. It does not form part of the company’s assets. If the company goes down, the units in the trust are safe (this is a bit of an over simplification but serves the example).

Rightly so, the Ovation Curators don’t believe that the Fidentia Curators have a claim against investors’ funds – they are not and never were Ovation assets. Unfortunately for the industry, the regulators and industry bodies have been deathly silent on the whole issue – what they fail to grasp is that if the Fidentia Curators manage to convince the court that they can lay claim to investors funds (from their unit trusts) then the industry as we know (and love it) is forever changed. The whole attraction of unit trusts will be destroyed in one ruling.

It is high time that ASISA (which includes the old Association of Collective Investments as well as the Linked Investment Service Providers Association) wake up to this fact and do some public as well as behind the scenes lobbying – they can not afford not to. The future of the entire unit trust industry hangs in the balance.

Just how much risk are you taking?

I met with a new client recently who proudly proclaimed that she was a “low risk investor” while passing me her unit trust statement. She has R1.1 million in a money market unit trust fund and it has been there for a few years.

While this might have been a good thing (from one perspective) over the past 2 years, I pointed out to her that while she was in “low volatility” portfolio, she had actually turned herself into a high risk investor without even realizing it. She may have taken the “roller-coaster” effect out of play but in doing so she has exposed herself to at least 3 other (probably greater) risks. They are:

  • Income tax: she may have earned ±R110000 interest on this amount, the first R19000 of which interest is tax free, but she will lose ±R32000* to tax. This will reduce her yield from ±10% to about 7% (which is below inflation).
  • Interest rates: in the past year alone, rates have declined significantly and cash yields are now below inflation.
  • Inflation risk: this is the greatest area of concern and while she may currently sleep well at night, the real value of her capital is decreasing on an annual basis and will probably never grow at a rate that is greater than inflation (see table below).

Investing is about probability and not prophecy. We don’t know which sector will perform best next nor do we know when the rand will weaken further or even if the market has bottomed. We do know, however, on balance of probability (built up over a very long time) that as an asset class, equities will outperform property which will in turn outperform bonds which will outperform cash (after tax). This is a fundamental consequence of the risk/return relationship. Statistics show that SA asset classes have produced the following real returns over time:

Asset class              Real return          Volatility

Cash                          1.9%                         1.3%
Bonds                        2.1%                         7.2%
Property                     7.6%                        19.7%
Equities                      7.6%                        22.3%

Source: Prudential Asset Management: 1966-2008, property since 1977

What investors (and advisors) don’t realize is that:

  1. You can’t consistently pick the winners (you’d be better off buying the losers),
  2. You can’t repeatedly time the markets (no matter how good you think you are) and c) If you want to accept cash returns as your worst case scenario, then you also have to accept cash returns as your best case scenario.

We need to remember then, that volatility is a function of the risk/return relationship! There are periods (which can extend for a number of years) when the equity markets can be extremely volatile – the way to combat this is to have a well diversified portfolio with sufficient access to cash (short term funds) so as to allow you to ignore the ups and downs in the short term (from a financial planning point of view this should be ±6 months income need).

It is the role of the financial planner to coach their clients to stick to their plans and be patient. What they need to realize is that markets are designed to transfer wealth – often it is simply from the impatient to the patient! The secret to accumulating wealth over time is to have a diversified portfolio (across all the asset classes) and to buy low and sell high. To do this you have to be patient! Remember you are an investor and not a speculator.

“The psychology of the speculator mitigates strongly against his success. For by relation of cause and effect he is most optimistic when prices are highest and most despondent when they are at the bottom.” (Benjamin Graham, Security Analysis 1934)


*this assumes a tax rate of 30%

Beware of life insurance savings products!

I admit that this is written with a lot of emotion but there have got to be few things that are worse for investors than life insurance savings products. Whether they are endowment policies or retirement annuities (new age or traditional) they have got to be the worst thing that an investor can buy!

I just cant understand how in 2009, when research shows that the average person will change jobs at least half dozen times during their working career, that insurance companies still insist on locking people into long term contracts where there are significant penalties anytime that they want to change their minds (or their jobs for that matter).

Take the following examples into account.

An investor joins a company that does not have a pension fund and she decides to take out an RA. She has 2 choices here:

  1. A unit trust based RA, or
  2. The life insurance RA

In the UT RA, there is no contractual period, she can pay a premium for as long as she wants to and can change it as often as she wants/needs to as well. If she stops the debit order she can pick it up again at any stage – she will not have to make up the missed premiums. There are never any penalties on a unit trust RA – ever! Problem is that on the UT RA there is also very little commission and as such, most advisors who work on a commission basis and who have sale’s targets, will not even offer the client the choice of the UT RA.

On the life insurance RA, however, she will enter into a contractual relationship to pay a given premium for a given period of time, escalating (or not) at a given rate each year. At that stage, the insurance company will work out all their future profits and expenses on the policy (including the commission) and they will account for these right then and there and take these from her policy (in many instances they will also charge the client interest on these fees that they have taken from her policy). Now if she ever needs to change (decrease or stop) the premium because she has moved to a new company that has a pension fund or for any other reason, the insurance company will work out their losses as a result of her “breaking” the contract and they will claw them back from her fund value. Big penalties and through no fault of hers! By law this is currently limited to ±35% of the fund value and even though you may try to find out just how this is calculated you will probably never get an honest answer (believe me, I have tried many times).

The process of locking clients into long term contracts is archaic and given the high mobility and turnover of staff in today’s society, I also think that it is completely unethical. So spread the word, don’t ever buy a life insurance RA – there is a much better way! If your advisor is not telling you about unit trust based RA’s then ask him/her why not and possibly look to find a new advisor!