Investments: the cost of focusing only on costs

By Opinion Time of article published Dec 22, 2021

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By Wynand Gouws

The cost of investing is a critical component in financial and investment planning. This should however not be the only consideration. Eliminating all unnecessary costs where possible is an integral part of an overall financial and investment plan. The impact of even low costs over the long term can be significant on the performance of an investment. For example, a R100 000 investment that earns 10% per year for 15 years and has an additional 2% charge per year will return R100 508 less than an investment that does not have the additional fee. An additional 1% per year charge will reduce the final value by R53 477. This is extremely important for retirement planning investments, which typically have long-term investment horizons.

Managing costs requires an understanding of all components of investment costs, including the costs for administration, advice, and investment management. It is also important to understand what you are forgoing when you make an investment decision if you only consider costs and don’t look at the bigger picture. Investors often get lured by the promise of lower or “lowest” costs and then get forced into a limited range of investment solutions or funds. This is often the only way low-cost platforms can survive – by forcing you into their own inhouse solutions and limiting your investment choice and freedom.

With many of the low-cost investment options you also forfeit the opportunity of getting professional financial advice. These options often rely on investors making their own decisions and having a deep understanding of the investment options, regulation, tax implications and behavioural biases in financial and investment planning. It is therefore important to consider the value forfeited in only focusing on costs and not getting professional financial advice.

Quantifying the value of advice

There have been several studies to quantify the value of advice. These studies initially only focused on the importance of investment returns and the impact good advice can have on realising market related returns by understanding and managing investors’ reactions to market “noise”. The best known of these is the Dalbar research, which quantifies the importance of not reacting to market noise and uncertainty and to hold on to a well-structured and considered financial plan even during times of uncertainty. These studies have evolved to now capture the overall value of advice, not only investment returns.

Even though the studies differ, there is a common thread in all of them, there is value in professional financial advice. The tenets of good advice and better financial outcomes for clients are coaching and behavioural guidance, appropriate tax planning, being invested in the right products, and active portfolio management and rebalancing. A recent study in the US by Russel Investments quantified the value of advice in 2021 as 4.83% a year, which is significantly more than the cost of advice, typically 1%.

Some other studies and research worth noting:

• International Longevity Institute (UK). The Longevity Institute focuses on the impact of longevity the impact of good advice in providing for people living longer. From a recent study they found advice can result in a 50% higher average pension relative to those who do not actively engage in financial planning and advice.

• Vanguard. Vanguard’s Advisor’s Alpha suggests that behavioural coaching is the single most impactful thing an advisor can do to add value to investors, adding, on average 1.5% of value, this is followed by Wealth Management adding up to 1.45% and portfolio construction adding up to 1.4 %. Vanguard estimates cost effective implementation can add 0.4% of value per annum.

• Morningstar. Morningstar’s Gamma research demonstrates that making sound financial planning decisions in five areas – asset allocation, withdrawal strategy, guaranteed income products, tax-efficient allocation, and portfolio optimisation – can generate 29% more income on average for a retiree.

• Additional research by Morningstar. Further research conducted by Morningstar suggests that offering clients personalised advice and using a combination of interventions, such as increasing someone’s pension contribution rate and postponing their retirement age to 67, can help 71.2% of households avoid extreme austerity.

In conclusion

The area that investors often get caught up in is the portfolio costs. To minimise portfolio costs investors often fail to benefit from the overall value of good financial planning. Even though the numbers from these studies differ, they do conclude that there is significant value in financial advice. Do not get lost in focusing only on costs.

Wynand Gouws, a Certified Financial Planner, is a wealth manager at Gradidge Mahura Investments in Johannesburg.

This article first appeared in the 3rd-quarter 2021 edition of Personal Finance magazine.

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