Investor Information: Tyranny of Costs

To illustrate the extent of impact different percentages may have on an investment, let us look at the situation where one invested a lump sum of R100,000 for 30 years and for the sake of simplicity we assume no costs were charged.

• At a 10% annual compound yield your investment will yield R1,744,900
• At a 12% annual compound yield your investment will yield R2,995,900
• At a 20% annual compound yield your investment will yield R23,737,600

Therefore, a 20% return over the above period is actually 13.6 times better than a 10% return.

Certain cost elements should be considered when choosing an access facility to the equity markets, namely:

• The actual trading costs when a transaction takes place on the FTSE/JSE
• The (up front) initial fee charged for access to or providing the facility
• The annual intermediation fees charged for managing a fund or portfolio
• The annual fixed membership or administration fees charged or involved

The latter fee has the least impact on the outcome of an investment mostly because it is not related to the size or value of the portfolio.

For example, the R1,200 annual Valana subscription fee on a portfolio of R500,000 represents a charge of as little as 0.24%.

The ideal scenario when choosing an equity investment facility will be one where you make your own trading decisions, either through a registered broker with no mandate to trade on your behalf, or through an on line trading facility.

Any method where you can avoid intermediation fees being charged that will erode the profits in your portfolio is strongly recommended.

To really grasp the impact of the three most important elements of an investment namely, compound growth obtained, term of investment and tyranny of costs, let us assume that R100,000 was invested at a gross average annual yield of 12% over three different terms and let us compare it using different platforms or facilities for such an investment.

Also, let us assume that except for the first two situations an average dividend of 4% was earned each year on the funds invested in the equity markets.

To illustrate the impact the table below shows the approximate outcomes obtained:

	Situation applicable	50-year term	40-year term	20-year term
	Investment free of costs and no dividends	R28,900,000	R9,305,000	R964,600
	Investment Fund with fairly high costs	R7,222,000	R3,027,700	R533,861
	One could argue that the overall yield should be higher as the dividends received by the Fund are included in the NAV growth of the Fund, but our experience found little evidence of it being so.
	Dividends not reinvested and zero costs	R39,652,300	R12,741,700	R1,287,400
	Dividends reinvested and no other costs	R205,384,700	R44,673,900	R2,113,600
	Added yield if dividends reinvested	417%	250%	64%
	Over the long-term, it would be very hard for any investor to beat a portfolio of quality dividend stocks where such dividends are reinvested during the term.
	If no intermediation fees applied	R31,675,600	R10,533,200	R1,144,200
	If a 2% annual intermediation fee applied	R12,121,167	R4,923,500	R790,200
	If a 3% annual intermediation fee applied	R7,492,200	R3,365,800	R656,560
	Profits sacrificed (re high and low above)	76%	68%	42%
	The question one has to ask oneself is whether the benefits, if any, obtained from giving a broker a full mandate is worth sacrificing such a large portion of one's profits.
	Expert trading direct on line with low costs	R34,937,000	R11,420,000	R1,198,400
	Giving broker a full mandate (small account)	R10,000,000	R4,213,000	R720,700
	Giving broker a full mandate (large account)	R12,449,700	R5,030,400	R799,150
	There can be little doubt, for you to enjoy most of your profits you need to be an expert with sufficient expertise and knowledge and you will need the time to do in-depth review and analysis.
	Using Valana source and on line trading	R32,048,400	R10,490,800	R1,114,000
With the correct application of the Valana facility one can almost be in the same position as the expert trader without needing all the expertise and without doing any of the homework done by such an expert.

From the above it should be clear that unless you are an expert on the markets and unless you have adequate time, skills and knowledge to analyse and select your own companies to invest in, the Valana model will probably be the most effective manner to enjoy better profits.

Brokers will, of course, be very quick to tell one that the annual intermediation fee they charge, where a full mandate applies, is for the good advice and stock selection recommendations they make and to some extent it is true, but you should decide whether you are prepared to sacrifice so much of your potential gain for this advice.

Research clearly showed that stock brokers are essentially more sales-orientated than they are good stock pickers. After all, their primary function is to get clients to trade as often as possible.

From the experience our team had during the past ten years with several broker houses, we came to the conclusion that although they mostly had good knowledge of the markets, they did not always demonstrate convincingly that they have the ability to select really good stocks.

They also tend to focus on the few popular liquid or large cap stocks and they seem to sell good stocks too soon.

The most important thing to realise is that they could never care about your money the same way you do.

[ Less... ]