How to make sense of complex financial products

How to make sense of complex financial products_1Our company consultants have been going through several training sessions with various insurance companies and each time we come away with enough reading material to fill a small suitcase or to choke a donkey. We are professionals and know more than 90% of all other people about insurance risk and investments and we find it difficult to not just understand and disseminate the information, to then compare and find the best solutions. This made me wonder: how do Mr and Ms Average South African make sense of it all?

We were comparing the reduction in yield of various products and I realised that most of our readers will not even understand the term, let alone its possible impact on their lives and investments. Today we will look at how to make sense of reduction in yield; where to find it; what it means; to know why it is important; and, who to turn to for help.

The suppliers and managers of funds are all expected to express their costs as a percentage of the contributions you make and to declare this to the investor. This cost is important, will impact adversely on the investment return and must thus be expressed. If a company uses 3% of the contributions it will reduce the yield by 3%. Thus, if the fund manager achieves a 10% return on the investment the amount that accumulates to your investment will be reduced by 3% (the reduction in yield) to 7%, simply because they will recover the costs from the gains.

When we compared the different providers we found that the reductions for all were very similar. We then realised that they may also raise a policy fee and even though this was not included in the reduction in yield calculations it will have similar adverse impact as would the reduction in yield. We found that policy fees varied between nil, R15, R28 and R45 per investment per month. If we express this as a reduction on yield on a R500 per month investment we found the following reductions from providers: nil; 3%; 5,6% and 9%, meaning that our reduced 7% return above will be further reduced to 7%; 1,4%; and -2%.

How do Joe and Jane Public imagine that they will make a good buy by contacting each insurer; know which question to ask; and, then make a sound investment decision? No wonder so many are left high and dry at the end of an investment term and find that they had a slight increase; no increase or even a loss on the amount saved.

There is only one conclusion: if you cannot locate a good investment adviser you will be best advised to leave your money in bank deposits. This is a poor solution as bank deposits will after tax keep you below inflation on your yields, but with massive savings it becomes possible. My father in law saved one third of his income each year, thus accumulating a whole year’s income in savings every three years. Even though he only earned 6% returns he still accumulated capital equal to 20 years of annual income over a 40 year working life, when adding together savings and interest accumulation.

How to make sense of complex financial products_2

We cannot all accumulate 33% savings each year and the good investment advisor on the other hand knows the needs and will work through all the details, disclose the cost and find the best performing fund on your behalf. His constant monitoring of investments and reporting to you will not leave you high and dry at the end and will afford you the opportunity to make several (sometimes annual) interim adjustments to gain the best results. It is far too daunting a task to attempt this on your own, unless you are the type of do it yourself that service your own cars and build your own houses.

Some research done on various managers revealed that even the direct supplier was only 0,4% lower in costs; did not disclose their policy fee; and, their funds performed below the rest. The net result will be that your investment would have yielded less with them than with most of the other providers. Not a good solution.

In our quest for best we have come across two offerings: one, where the investment administrator take no fees until they have put inflation plus 3% in your pocket; and two, a personal fund manager who emulates the large institutions and invests your money in your name for 1% to 2% fees, depending on size of the portfolio being managed.

Whatever the results we must save! We must also accept that a nil cost is an impossible dream. We must thus find the best results where the gain over cost is biggest and even though an advisor may add an additional cost his expertise will help you in gaining the best net returns on your investments.