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!

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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!

Do the maths!

Just been reading the article about Old Mutual’s new credit card where the reward is an innovative “units in their money market unit trust fund”. On the face of it this is a great rewards offering…but do the maths and I cant believe how OM can get it so wrong so often.

They are offering an Amex card and a Visa card with the Amex card offering a higher reward than the Visa card – problem is that there are still many places that don’t accept the Amex card and so most people will end up using the Visa option.

The visa card option will give you 0.5% of your spend in money market units. So if you spend R10000 then you will effectively get R50 in units each month…if you spend R5000 then you will get R25 in units each month. Not bad until you factor into this the cost of the card…at R35 per month, unless your credit card spend on the Visa option is R7000 or more it is going to end up costing you…

There are so many seriously better credit card reward options out there…I’ll be staying away from this one.

P.S. In 2007 there were over 15 billion credit card solicitations in the US and the average family owed more than $8000 to credit card companies although many researchers believe the figure to be substantially higher at $12000.

5 Aug 2009

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5th Aug 2009

The Ovation Curatorship saga continues…the court case that was scheduled for yesterday has been postponed yet again, this time to Sep 3 (but I wont be holding my breath).

This is unbelievably frustrating and emotionally draining (I write this as both a financial planner dealing with clients as well as an investor in Ovation).

Just so you know, we have been writing to the regulators and curators fairly often but have received fairly terse replies in most instances. We have now also written to the head of ASISA (Association of Savings and Investments South Africa) as well as to the press (Personal Finance). When (if) we get a response or if we have any more news on the Ovation saga, we will post it here so check up once a week to see if there is any news.

You are also welcome to give me a call if you have any questions.

Gregg

Letter from ASISA CEO

16 July 2009Asisa

Dear Gregg

While we understand your concerns, it is regrettable that you appear to be under the impression that ASISA is in sleep mode and oblivious of the latest developments in the Fidentia/Ovation saga.

I can assure you that we at ASISA have been following these developments closely and that we are in regular contact with the FSB on issues of concern.

However, irrespective of the legal opinions expressed by the curators of Fidentia and Ovation, the unit holder assets invested on the Ovation platform are protected by law. Therefore, in terms of Cisca, this money cannot be accessed and used by any party other than the legal owners, namely the unit holders.

If Fidentia’s ill gotten gains were invested in these unit trust funds together with the money of other investors, then Fidentia’s share may be disinvested and paid back to Fidentia once the assets are released. Equally, once this happens, all other investors will also be disinvested and their assets returned to them. As you know the release of these funds had been blocked by one individual investor.

Since it is illegal to access unit holder assets held within a unit trust fund, we have no reason to believe that a court would overthrow the legal protection offered to investors.

As ASISA we have to allow the curators to follow their processes and to debate and test legalities. While we may not agree with some of the views expressed, ASISA is not a part of this process and has no right to interfere, especially since we do not see an immediate threat to investor funds. As pointed out earlier, the FSB is well aware of these developments and of our views on the matter.

If you remain concerned about this or any other issues, please feel free to contact me. I also invite you to pay a visit to the ASISA offices at your convenience so that we can provide you with an overview of issues high on our agenda. You are welcome to raise any concerns you may have.

Yours sincerely

Leon Campher

CEO ASISA

It aint over till its over

I cant help but think that with the markets having run as hard as they have since their lows in November last year and March this year (JSE is up >34% since then) that either we have been duped into believing there was a huge crisis which never actually existed and have now missed the best buying opportunity (perhaps ever), or else, the crisis is not over, the issues have not suddenly gone away and things have not returned to normal as we knew it. As a result there is probably still quite a bit of volatility lurking about…if you are investing money, be careful…

At this stage I would be inclined to phase funds in over the next ±3-6 months to try to iron out some of the potential volatility that is still lurking. I don’t think it is over yet…

So take a step back from all the noise around you (in the form of the daily newspapers, websites and TV shows) and get a little perspective. Also give some serious thought to investing funds offshore – developed markets are still offering reasonable value and the rand is still strong (remember we were at R14/$ at and R20/£ at one stage).

Thats’ all for now