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

The real cost of the bond…

I read with interest the comments from “experts” telling people to resist yesterday’s interest rate by not reducing their bond repayments. This makes a lot of financial sense but the comments from readers of the article clearly shows just how cash-strapped many people are and for many, even this cut will not be sufficient. (Although this is difficult to understand given that we are almost back to where we were just before rates started climbing). Clearly there is a lot of emotion out there…

One of the biggest issues around bonds is that most people have no idea of the time-value of money and as a result have no idea of the total cost of their house over the 20 year period. The table below shows the repayments and total cost on a bond over the full term as well as what the required payment would be if someone wanted to pay their bond off over 15, 10 or 5 years. It also shows the subsequent saving in interest as a result of paying it off more quickly. R1 million bond over various periods @11% interest

Period      Payment/Mnth   Ttl repayments*       Difference                Saving
20 years     R 10 322              R 2 477 252
15 years     R 11 367              R 2 045 621              R 1 045            R 431 631
10 years     R 13 772              R 1 653 306              R 3 450            R 823 946
5 years       R 21 747              R 1 304 457              R 11 425          R 1 172 795

*this is the total cost of the R1 million bond over the period.

What most people fail to realise is that if they just leave their repayment where it is before yesterday’s cut, they will pay the bond off in just over 16 years and as a result will pay +/-R321000 less in interest. It also makes sense to build in an annual increase in your bond repayment – in much the same way that you have annual increases in your pension, RA or life policy contributions – by putting an annual escalation of 10% on the repayment you would pay your bond off in under 10 years at current interest rate levels and would save more than R825000 in interest!

Remember too, not to let the bank take the premium for the home owners insurance off your bond – you end up paying interest on this amount for the full term of the bond as a result (read the blog It’s so easy to save money!) for more on this.

Just because it is raining it does not mean the drought is over!

One of the things I enjoy doing is collecting rainfall figures…I have been doing this for over 9 years and have built up a bit of a data base. I know this has nothing to do with financial planning but it is probably a legacy from my student days when meteorology was one of the subjects I studied.

Earlier on this year, I posted a blog called “Will it ever rain again in Cape Town ?” This was during one of the driest starts to the year that we have had in Cape Town in at least the last 9 years and also during a time when it seemed that most of the Cape-fold Mountains were on fire. The just of the post was that as sure as winter follows autumn, it will rain again – even if it did not seem likely at the time. I reasoned that in the same way, the equity markets would recover – that’s what they are designed to do – and that it was not the death of equities as we know it.

Anyone who was sitting in cash and trying to time the market was in danger of missing out on its recovery. Sure enough, both “forecasts” have happened – it is raining as I write this, and markets are up (significantly) from their lows. The problem now though, is that if you ask anyone about how much rain we have had, or about how dry it still is in Cape Town) most people will answer that there was never any doubt in their minds that it would rain again or that there is no way that this was the driest start to the year – after all, look at how much it is currently raining (it was still, however, the driest start to the year that I have recorded in 9 years).

This phenomenon is well explained by behavioural finance! People tend to place over emphasis on the current and as a result tend to forget the past. So anyone who thinks that because equity markets have run hard and recovered well from their lows, that all is over and that there is no volatility risk from investing in shares, they need to remember the past.

Equities are the most volatile asset class and there will still be (significant) periods of (significant) volatility ahead. If this is going to affect your income and/or sleeping patterns then perhaps you should not be in them to the extent that you are. Equity investing requires time – 25% in 6 months is a great return but this is not a significant period of time! The way to iron out the volatility is to diversify your assets and to give your equity portion time.

So watch out, there could still be some dry spells ahead. Just because it is raining it does not mean the drought is over!

Think before you swipe!

On the face of it, the Discovery Credit Card and Pick n Pay tie up is very attractive; pay for my Pick n Pay shopping with my Discovery Card and get cash back from Discovery every month (depending on my Vitality status of course). And it works – for the past year or 2 we have been getting back a few hundred rand each month. I know that Discovery and Pick n Pay have struck some sort of deal and I know that Discovery’s whole aim is to keep people healthy because this is cheaper than treating sick people…and for many people it appears to work, but when Discovery introduced the Healthy Food offering with promises of even more money back each month I started thinking about where “catch” is… after all, there are no free lunches and someone (probably me) is paying for this “free” benefit.

The answer, I think, lies not where you would expect it but rather in a very interesting bit of research that I discovered one day when reading about debt and credit cards. The research (from the USA ) is that people who buy day-to-day goods with a credit card are likely to spend 12-18% more than people who pay cash. More significantly, people who pay for food (and eating out) with a credit card will spend up to 54% more than those who pay for these expenses with cash. Seem unbelievable? Think about it! When you swipe your credit card, there is no emotional attachment to the purchase – you don’t feel it immediately. In fact, think back to the last time you swiped your card…what was the amount? I have amazed myself with this question. The number of times I have swiped my card, signed and walked away only to think a bit later “what was the amount”? Now imagine if you paid with cash and had to take R1500 out of your wallet (which you had to draw from the ATM)… I bet you would think a bit more carefully about whether or not you actually need everything that is in the trolley. Or think about the following scenario: you are on your way home from work and you need to pop in to buy bread and milk…but you don’t have any cash on you…so you use your credit card instead…but “bread and milk” is too little to put on a credit card so you pick up a magazine, some chocolate, chips and then you pay with the card…see how easy it is to spend up to 54% more? (In fact, the Healthy Food advert itself implies that people will end up buying much more than they need – think about the truck load of food that gets dumped on the lawn.)

I am not against credit cards (they have a place) but debit cards are a better bet (and safer than cash) – you cant spend money you dont have. I am also considering making June a “cash only” month and seeing if I actually end up spending less (I know it will be skewed because I will be more aware of what I am spending but isn’t that the point?)

Think before you swipe!