Funds with low-cost fees are bound to offer more value – and the lower, the better, right? Well, not always – and yet this myth persists. Here’s why choosing a fund based primarily on fees could cost you more in the long run.
Fees are often the key factor considered when assessing savings products across industries, and it’s easy enough to see why – they can be captured in understandable numbers, tabulated and ranked. But just because something is easy to grade, it doesn’t mean it’ll predict which product will help you achieve your savings goals.
As always, a little perspective goes a long way. While some insist lower fees will make all the difference in retirement, the impact of this one variable is frequently overestimated, says Guy Chennells, Head of R&D at Discovery Employee Benefits.
“Investors often place the greatest emphasis on costs when choosing a retirement fund, but what people don’t realise is that once fees are in a reasonable band, they have a very limited impact,” he notes.
Why fees aren’t the only – or most important – factor to consider
A recent analysis by Discovery Invest demonstrates this. In the ASISA Multi-Asset High Equity sector, the correlation between total expense ratios in 2008 and the subsequent 10-year net-of-fees returns to the end of 2018 was -0.21.
Correlation is the degree to which two variables vary together. The closer a correlation is to 1 or -1, the more significant the indication that one variable can predict the other. So -0.21 is a weak negative correlation and indicates that fees are actually a poor predictor of investment returns.
In fact, when we compare the cumulative performance over 10 years of portfolios from the ASISA Multi-Asset High Equity sector, we see scenarios such as a highly-priced fund outperforming a low-cost one by 77% net of all fees. This despite the fact that the total expense ratio of the ‘expensive’ fund was over 1% higher than the low-cost fund. That said, you can also find examples that show the opposite result – so the conclusion is not that higher fees means higher performance. Rather, it’s that low fees do not mean high performance.
No nation is immune
The inability of fee-saving to solve the crisis of insufficient savings in retirement is not unique to South Africa. In the United States, where the vast economies of scale in passive asset management have resulted in incredibly low asset management fees, the statistics on retirement savings are concerning.
Three out of four baby boomers (the over-60 generation renowned for being hard working and self-reliant) are not confident that they have saved enough for retirement. These are people who are or should be retired and who had an unprecedented 50 years of booming economy and market returns to help them grow their savings. This is merely one example – and a sobering statistic.
Choosing better criteria
‘‘We should certainly ensure managers have reasonable fees and credible investment management processes that produce consistent performance outcomes,” says Chennells. “But once the outliers are filtered out, relative fees are no longer a sufficient decision-making tool. The industry needs a new lens for assessing retirement fund providers.”
Now that most benefits of a fee-saving battle have largely materialised, a more fundamental question arises: do the existing good-value retirement funds achieve their purpose? And if not – what does work in enabling people to make sounder financial decisions, save more and retire well?
3 questions you (or your financial adviser) should ask your retirement fund provider
The good news is that there are far smarter ways to assess retirement fund providers. You need to start with the goal – and that is to retire well. So ask your fund provider the following 3 questions:
- What are you doing to mitigate against threats to people retiring comfortably?
- Will you take proactive steps to help me save sufficiently?
- Are these steps measurable and effective? Get them to show you how.
“In South Africa, the biggest problems are low contributions and preservation rates. The amount investors contribute and the length of time for which they save without withdrawing are by far the most significant drivers of ultimate savings success,” says Chennells. Help with these kinds of factors is what you should consider to select a fund provider that really delivers.
“At Discovery Invest and Employee Benefits, we’ve focused our offering on providing powerful incentives to drive these positive behaviours in individuals, helping them make better decisions for their retirement,” says Chennells. “Through partnering with our clients to make the right decisions, we can effectively help them achieve their retirement goals.”