Irish Financial Review

Understanding the impact of fees and charges on your investment strategy

Maintaining a robust investment strategy that will reap a positive financial outcome throughout your life is a complex process that involves a carefully managed combination of the avoidance of unnecessary risk, maximizing of returns and understanding the impact of fees and charges on the long-term value.

For many people, a primary driver to invest in any range of asset class is done on the basis of long-term financial needs. In fact, the nature of investing should always be long term by nature as short-term goals will be near impossible to achieve without the presence of significant risks that can result in either a lot of money being made in a short period of time or significant loss of capital.

In recent years, there has been a substantial increase in the debate about the need for more people to take a more active role in their long-term financial well-being and as a result, more investment options are being introduced into the market that offer varying promises of investment returns. But returns are only one part of the overall equation for any would-be investor to consider their options.

A less discussed feature of many investment vehicles today are the actual charges that come with them, and these are not insignificant. In fact, in recent years, it has not been uncommon for some investments to generate relatively little in the way of overall return once investment charges are factored in. This is not to say that those who manage investments are doing anything wrong, this is as a result of both a combination of how difficult the overall international investment climate has become as well as the actual cost of managing a fund.

That said, it is important that consumers are aware of charges, how they work, how they are applied and what their eventual impact will be on their money.

So what are the typical fees and charges that apply?

If you have an existing investment fund, you will be paying annual management fees of one kind or another. These fees are paid to account managers whose role is to ensure that your investment fund is monitored and placed in the correct ‘risk categories’ to met your long term goals. For example, many fund managers will generally invest money in small and large companies as well as many other asset classes to ensure that the long-term financial goals of clients are met. It requires a lot of market knowledge, of trends developing as well as other factors such as local political risks, competitor risks and so on.

In some older investment plans, it may not be unusual to pay as much as 3.5% of the annual fund value in yearly charges, which could end up being more than the value of the return in any given year. In the last number of years, the difficult international investment climate and especially, the increasingly difficult Irish investment climate has made investing incredibly challenging. So it is little wonder why some investors question their strategy when they receive a copy of the overall investment value.

Newer investment fund managers typically charge less than half , but you need to watch out for how well or poorly a fund manager has performed in the last number of years before you make a decision to move your account if you feel you are being overcharged. However, great investment managers are well worth their money. They track the markets, they understand trends and they know where to avoid risks…and take appropriate risks where they are likely to yield a positive return.

Exit tax – while an exit tax is not a management fee per say, it is the elephant in the room as far as the long term value of any investment strategy is concerned. This extraordinary level of tax is plied on the growth value of the investment. It must be factored into the math when evaluating long term value.

Long-term investment strategies are becoming more and more difficult for many. Difficult economic times, reduced incomes, rising costs including rising mortgage costs are making it difficult for a growing number of people to actually find the necessary funds to invest. However, for those that are presently or may be considering future investments, understanding the primary costs associated with investing will assist them make more informed decisions and plan accordingly.

Finally, for those not fully familiar with investing, it is an incredibly complex field that often changes rapidly. Many times, investments that hit the newspaper headlines may actually be in the decline. If you are serious about investing for the long term, it is important that you take a healthy interest in the world and what the main drivers are. Also, if you are preparing to part with some of your hard earned money, consider the merit of paying for some professional financial advice. Remember, an advisor that does not charge you a fee may be looking to sell you something so it their advice really independent? It is important also that you understand what annual / management fees you are going to have to pay and consider the long-term track record of the fund / fund manager as you prepare to make that important investment decision. Be informed and pay for professional advice.

Add on:

If you have an investment fund which has been in place for many years, it may well be worth your while to hire an independent financial advisor to review it. In recent years, greater competition among funds and fund managers has resulted in a sharp fall in fees which has resulted in a significant long term boost in investment performance.

In an era where taking greater responsibility of your long-term financial well being is growing, it is also important that you become aware of the general risks that will affect your financial well-being in the future. A robust investment strategy should see you through but you need to take an active role in how international events and trends will affect your money and your investments. Even if your investments are with the best fund managers, don’t leave it sit.

Pay attention and ask questions. Ultimately, the only person that really will care about your financial well being is you!

Diversifying your way to a better financial future

We are all being asked to take a more active role in our long term financial well being. But doing so requires skill, knowledge and planning. Before delving into the issue of diversification, first, it is worth assessing the actual long-term risks that we need to prepare for and plan against if we are to develop an investment strategy that is likely to generate the best outcome for our money:

  • Narrow spread of investment risk: This is a major feature for many people as was highlighted in the examples of so many people who had invested a significant proportion of their personal wealth in property or in bank shares, which were heavily linked to the health of the property market, when the value of both collapsed, so the personal wealth of a lot of investors. But these lessons should have already been learned. Before the property and bank collapses, there was Eircom where many people also lost a great deal of personal wealth and which should have served as a valuable lesson, but seems to have been either missed, ignored or forgotten
  • Living longer risk. Many people are now living longer these days thanks to advances in medical care and new drugs, as well as important changes in lifestyle. However, the down-side is more and more people are at risk of living beyond ages for which their investment strategies may cater for. When it comes to a well thought out investment strategy, one must factor in how many years their investments will be needed for when they no longer have a regular income.
  • Inflation risk is greater now than at any point since the Euro came into existence. The European Central Bank can and may use inflation to whittle away some of the overwhelming sovereign debt that continues to dog so many countries that share the common currency. If this happens, it will have a negative impact on any investment strategy, especially those that generate low levels of return. In recent years, the cost of purchasing utilities (fuel, electricity) have been on the increase and have been resulting in less and less disposable income for many retirees that depend on a fixed income in order to survive. Also, more recently, a significant prolonged drought across much of the US has resulted in a significant fall in food crop yields. Bad weather has also had a significant negative impact on food production across much of the EU and wider European region. As a result of US and European food production challenges, the cost of food is expected to rise. And in the long term, rising global populations are expected to continue to place significant upward pressure on most commodity prices, making that loaf of bread or gallon of fuel more and more expensive.
  • Unexpected health care risk is another form of risk that we must all plan against. Ensuring against the probability of long-term health problems can sometimes be achieved by simple lifestyle changes. Genetic problems are a different matter. However, all health problems pose a significant threat to the long-term viability of even the best investment plans.

Diversification is relatively simple in concept but it requires constant attention monthly, weekly and perhaps even daily intervention to the makeup and structure of a personal investment pot to minimise risk as much as possible.

A well diversified investment plan will spread your money across a variety of risk categories. For example, while cash is often deemed to be among the lowest risk grades, it is susceptible to inflation. Putting all of your cash in a low interest bearing bank account may not be the best option if Governments internationally introduce monetary policy that cause inflation to rise. Equally, as referenced earlier, record poor weather in the US and EU has resulted in a record low harvest for corn and other crops which are expected to cause food prices to rise significantly. This will reduce the value of even the best investment strategies so it is really important that proper planning is put in place to protect any investment against the scourge of inflation. That said, cash continues to be a standard conservative risk category that will continue to serve a useful purpose for some time to come, but it should be one of a well balanced investment strategy.

At the other end of risk scale are equities (company stock). Investing all of one’s money into on company carry enormous risk that any fund manager would advise against. Investing into company shares has a useful purpose but it should be done sparingly and with a high expectation of loss. But since all companies are not the same, investing into different companies and across different industry sectors will help disperse the risk.

It is also highly recommended that any investment diversification factor in the age of the client for added measure. The conventional rule of thumb calls for a lowering of risk as one gets older. In other words, take more risks when you are young, if you lose on an investment, you have time to recover. Take fewer risks with your investments as you age as you will have less time to recover before you need your money the most.

Finally, I cannot make this point enough. There is no substitute for proper independent advice and the public should not be afraid to pay someone to provide them with good advice as to their options.

Add on

A well diversified investment portfolio should carry varying degrees of high and low risk investments that cater to the long-term lifestyle needs and goals of the customer. Age is an important determinant of the levels of risk and it is really important that the investor understands the links between their own personal goals, the propensity of loss, the types of risk and what their long-term (as well as short-term) goals are.  Holding cash may seem wise but if it is the only investment strategy, then it is likely to prove a flawed one in the long term. Long term planning is perhaps the best investment diversification plan. Finally, don’t be afraid to pay or advice. It could be the best investment you make.

Safe havens for your cash.

Let’s be perfectly clear. There are few guaranteed safe havens for your cash these days. In fact, the concept of a safe haven for any investment fund is a bit of an oxymoron.

With the onset of the Sovereign debt crisis that exploded in Greece and since spread to Ireland and Portugal and now looks like consuming Spain as well, the once unquestioned security of Government issued bonds has gone out the window.

Even the cash we carry in our pockets and hold in our bank accounts, while often cited as one of the safest havens of all is itself highly exposed to long term risks that severely undermine as a safe haven for future retirement needs. In the case of cash, inflation is the greatest risk, and in recent months, signs are emerging that various events in the US and EU could cause inflation to accelerate in the months and years ahead. Whether or not serious inflation materializes is purely speculative.

That said, risk is relative and you will still need to actually put your money somewhere. Here are some of the primary safe-haven options:

Under the Mattress – forget it. It will certainly make for a bad nights sleep. Plus, it does not pay interest and as listed above, the return of inflation could render that lumpy bundle as worthless bundle in 10 – 15 years time.

National Solidarity Bond – Probably one of the better options available in the market currently. Remember, you do have to lock your money away for a set period of time before you gain the full benefit…up to 50% return, but it is Government backed and we don’t expect them to renege on their promise to pay p when the time comes.

Fixed-term deposit accounts – some banks are still paying a hefty premium of 3 – 3.5% provided you lock your money away with them for a set period of time. KBC Bank, EBS and Permanent TSB, Rabo Bank (their interest rates are lower as they present a lower institutional risk), Investec and Nationwide UK are the primary competitors for your money, paying consistently in the region of 3.25% range for your hard earned money. On this point, it is worth noting that you will be liable for a hefty DIRT tax, which will reduce the return significantly. Remember, your whole reason for putting cash away is to earn a return to outperform the long-term level of inflation. Otherwise, you will find your money becoming less and less valuable as time passes.

Government bonds  – Government bonds, while being savaged by the markets in recent years continue to offer a level of safe haven  have returned positively for those funds that have invested in them. There are many funds that actively invest in various Government bonds as their investment strategy. In recent years, some top performing countries (Canada, Germany and the US) have generated low returns while higher risk countries (Italy, Spain) have returned relatively generously as a means of enticing investors to invest.

Gold  – gold has continued to rise in value in recent years as a hedge against both uncertainty in the stock market and rising concern that Government issued bonds carry elevated levels of risk. Gold and other precious commodities carry a level of risk insulation that has been attractive to many international investors. However, like all cases in the past, gold also not carries an elevated level of risk that it could be abandons as quickly as it was purchased if general fear in the Sovereign debt issues in Europe begin to abate. One should invest in physical gold as opposed to through an EFT. Paying a small storage fee would be a wise investment.

Property prices in the US are beginning to show a strong recovery. Here in Ireland, property is also showing the early signs of stabilizing after a near 5-year fall. That said, property as an investment category will probably remain outside of the grasp of a majority of people as bank lending for this sector is near non-existent.  In more recent days, there have been headline stories of quick returns being made on select property types in very select locations. But property is an asset class that can be difficult to sell, especially in difficult market conditions.

Pay for good advice: There is no substitute for proper independent advice and the public should not be afraid to pay someone to take care of their financial well being – it is important, however, not to trust someone just because they have a nice suit or drive a nice car. It is important to understand what you are buying and to review every aspect, fund choice, charges and performance annually.

Add on:

Money is precious, it is scarce and it is increasingly difficult to hold onto. Protecting your money requires taking an active interest in where the greatest and the smallest risks lie. For many people, developing a strategy of where they should put their money is best done by spreading it around. In recent times, many arguments for keeping money in cash have been made. Perhaps this argument had value but today, the world is fast changing. Signs of inflation are creeping into the overall world economy. Protecting yourself against the risks posed by inflation is key if you are to ensure against the loss of value of YOUR cash.

It is also important that your cash is invested in a mix of investment classes. Some should be relatively ‘liquid’ which means that you have access to the cash if needed. Gold is a good example as it can be sold easily. But the best safe haven will come from getting good advice. In the long run, the cost of good advice will be miniscule compared to the long term value of your investment choices.

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