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Self Managed Super Fund (SMSF) Article
Fees must be disclosed in dollar figures
By Tony Negline.
This article may be out of date.
8th December 2010
In my article last week I discussed financial services fees. In particular I focused on the need to have these costs disclosed in dollar terms as opposed to percentages.
This week I want to continue with the same theme but use a practical example.
The Australian Securities and Investments Commission claims on its consumer website (www.fido.gov.au) that paying 1% per annum in fees over a twenty year period can reduce your end benefit by over 20%. If true this is a significant impact.
Suppose in March 1982 you decided to invest $100,000 in the ASX 200 All Ordinaries Index. Based on the Australian Consumer Price Index this would be equivalent to about $309,000 in 2010 which is a fairly typical amount that many superannuants and retirees would have invested in the Australian sharemarket.
In March 2010, that is 28 years after the initial investment was made, the $100,000 investment would have grown to $1.1m. This investment assumes that any dividends paid have not been reinvested into the Australian sharemarket.
This result also doesn't take into account the significant impact of super fund tax on retirement benefits. We'll leave this for another day.
This 28 year period is many year less than the time period that most Australian super fund members can expect to have their money invested for retirement. Moreover our example investment period has been punctated two significant boom periods followed by two severe market corrections. No one could claim that the last 28 years have hardly been a sedate period in financial markets!
Perhaps these results might give investors a lot of confidence to invest for retirement.
However our $1.1m result does not assume any management fees. Total fees on super investments are highly variable. The fees might range from anywhere between 1% per annum to over 3.5% per annum.
How often are these fees charged? This will very much depend on how often earnings are allocated to super fund members.
If unit prices are created daily then a portion of the annual percentage management fee will be taken out every day. Conversely if returns are determined once per year (very typical in Self Managed Super Funds) then the management fee will be withdrawn once per year.
Remember that most super funds will charge these fees when times are good or bad. It has been my experience that no one seems to mind paying these fees during periods of high investment returns. The reverse also seems to be true – there is often deep anger at handing over fund manager fees when returns are poor.
What is the impact of "low" percentage super fund fees?
A 1% fee per annum reduces the $1.1m to $800,000. That is a reduction of 27%.
If a 2% per annum fee is charge then the $1.1m reduced to $600,000. That is a 45% reduction.
What about a 3.5% per annum fee means an investor only receives $400,000 at the end of the investment period. That is, total fees eat up 64% of the no fee example.
In these examples I have assumed that a portion of the fee has been deducted at the end of every month.
In real life these total management fees might include the cost of providing financial advice and in some cases they will be added onto the fee payable.
It is a fundamental human right that a worker receives a fair wage for fair work. A key question for investors is whether charging fees as a percentage of assets under management produces a fair result for the investor and super fund operator.
Before reaching a conclusion on this it's important to realise that the above results show the impact of these fees not the actual fees being paid.
For example in the 2% per annum fee example, $219,000 in fees are paid but their impact over 28 years is over $500,000 in lower returns. ($1.1m less $600,000). Over 28 years, the $219,000 fee is equivalent to paying someone an average of $7,800 per annum to manage your money.
Some investors will argue that this fee is a rip-off whilst others think it's reasonable.
It is true that super fund expenses have been falling in recent years.
It is also true that a few fund managers will reduce their fees if they don't perform to expectations (for example they perform below a benchmark).
Conversely some fund managers will take a higher management fee if they exceed a higher benchmark return. For example, they might take a 1% per annum management fee up to an investment return of 20% and then 50% of everything above that threshold. In this example if a 30% return was earned then they would charge a 6% per annum management fee.
So what is the right fee? The market should decide this. However I very much believe that the average super investor is not fully informed about the fees they are paying or their long-term impact.Any reform that the government makes to the provision of financial advice must demand that all product fees are displayed in dollar terms. Moreover the impact of those fees on long-term outcomes (assuming appropriate assumptions about the future) must also be shown in dollar terms.
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