Your unit trust doesn’t cost you 1.7% a year it costs you R15 897 a month you fool!

Happy Easter, don't let the bad fish eat all your chocolate

Happy Easter, don’t let the bad fish eat all your chocolate

If you’re thinking that title sounds familiar you’d be right. Once upon a time I wrote an article based on real people called “Your car doesn’t cost you R5800 p/m it costs you a million dollars you fool“. One of those people was my wife, the other, someone I worked with. This didn’t have a good outcome. In the first case, even though I mentioned how both my wife and her Mini had rather sexy rear ends, she wasn’t happy at being used as an example, and promptly let me know that.

In the second case my use of pseudonyms for said colleague’s name was insufficient considering there was no use of a pseudocar in the blog post. The very next day after it was published I had an email in my inbox saying “Nice article” with a link to what I wrote. I felt anything but nice, especially due to the fact that the fast car loving colleague was a person I quite liked, and wasn’t actually remotely a fool, he was simply an Audi nut.

Thanks to that experience, I’ve learnt my lesson on using family and friends as examples. It’s not worth the risk of upsetting a friend or sleeping on the couch. That’s why this post isn’t about a family member. It’s almost certainly also not about a friend. Maybe. Let’s just say it’s about a fictional character named Art. And no Art isn’t short for Arthur, Bartholomew or Stuart. In fact he doesn’t even have a name, he’s completely made up. In the same way that criticism of the president is completely racist…

Now fictional Art is quite astute financially. He’s avoided the trap of buying a house far bigger than he needs. He’s actually even avoided the trap of buying a house, and rents instead. Art has also never bought a new car. In fact, he only recently replaced his completely worn out first car with another boring used Japanese sedan.

These things along with a number of other frugal habits passed on from his parents has resulted in Art being able to save quite a lot. Around R10000 a month lately. Thanks to that he’s recently crossed the R1 million milestone in his investment accounts at the relatively young age of 29 and a bit years, something he is rightly very proud of. What’s even more impressive is that Art achieved all that, while swimming upstream. Not just any stream, but a piranha infested one.

You see Art never really knew much about investing, so simply spoke to his dad’s piranha investment adviser who told him to buy a specific big name brand unit trust*. Now I don’t know whether or not this unit trust provider paid the adviser the most in commission, but Art was told this was the right thing to do and blindly went along with it even though it has a total expense ratio (TER) of 1.7%. That’s probably somewhere in the middle of the pack in terms of unit trust fees, and a rather healthy bite for the hungry adviser.

Now I’ve often told Art he’d be so much better off by choosing a lower cost investment, but he’s never made any changes. I told him once more after he mentioned joining the double comma club, and again he said he doesn’t want to change. This time he had a logical sounding reason. “1.7% is far too little to worry about, and if I do change, I’ll have to pay a fortune in capital gains tax (CGT) to the sharks government.”

Now considering that nearly R600 000 of his R1 million is from growth, Art could expect to pay a lot in CGT. At the current rates, he’d pay just about R100 000 in CGT, too much for him to accept, after all, his fees for the next year will only be around R17 000, and the year after won’t be  much higher. It would take years for the fees to exceed the total CGT, so it’s probably best to stick with the unit trust. Or is it?

To decide on whether it’s better becoming shark food or piranha food we first need to get some facts.

The first question we have is will Art get value for money from his fees? I’ve written many times before about how most unit trusts lose to the index. Happily, since S&P release their annual scorecard in the active vs passive battle every April, we can now look at updated figures. The update for South African funds was more of the same. Over a 5 year period, 77% of funds which focus on the JSE lost to the index. If you’re considering a global fund run by a South African firm things are far worse. In that case 93% lost to the index. And remember, those are just the surviving funds, nearly 20% of the biggest losers were closed down by their red faced, sweaty palmed fund managers.

There’s more bad news too. In the US scorecard we now have 15 years worth of history from S&P. This gives us a really good rundown of what you can expect on the sort of time-frame we’d have for retirement savings. Over 15 years 92.2% of US large cap funds lost to the index, 95.4% of midcap funds lost and 93.2% of small cap funds. I think the term for that is a whitewash. And these were the scores for the funds that survived. More than half of the funds that were around 15 years ago have closed down.

So on average you’re going to lose by buying unit trusts. The average amount you’ll lose by is 1.75% per year. Some funds lose more and some funds lose less, care to take a guess how to tell which ones will lose by more or less? That’s right, the more expensive the fund, the more you lose! It seems like fund management companies live in a parallel universe where quality is cheap and absolute rubbish expensive. The only other crowd I can think of that live in the same universe are politicians.

With that in mind I’ve built a new calculator. You tell it how much you already have, how much you invest every month, and how many years you plan on doing that before you retire. It then works out how much you’ll be spending in fees over the total period, and also per month. To make it work for both exchange traded funds (ETFs) and unit trusts, I’ve only discounted the performance by the total expense ratio. That’s reasonably accurate for ETFs**, but unit trusts would actually lose a little more.

So let’s plug in the numbers.

Piranhas (keeping the unit trust and not paying CGT)

What a piranha will cost youSo in the case of the piranha, Art keep his million, but the hungry little fishes take tiny nibbles out of him every single year. Since Art is still young, this will happen for at least another 30 years, leaving him with this outcome:

What's left after the many Piranha attacksAs you can see, all those annoying little attacks have actually claimed R5.7 million out of a potential R18.4 million in growth. Can you see that Art. You’re not actually paying 1.7% per year, what you’re really doing is paying R15 897 a month, every month from now until you retire. All that for what will certainly be under performance. That’s staggering! Let’s see if you’d do any better losing a leg to the sharks.

Sharks (paying the CGT but getting a better total expense ratio)

What a shark will cost youSo it’s time for the shark attack. In this case you lose 10% to CGT immediately. That’s probably a leg up to the knee. Fortunately though it’s a once off attack and then you’ll be left alone for the rest of your life. Now most South African general equity funds compete against the JSE top 40 index, so in this case we could have chosen the Satrix 40 which costs 0.38% p/a to compare with, but since we’re smart we know we can buy the Ashburton top 40 which does exactly the same thing for just 0.18% p/a. Here’s the outcome:

What's left after the one shark attacksHow’s that for a difference. The shark attack victim is R4.3 million rand better off than the piranha victim. Yes the initial capital was less, but the attack only happened once, it was a transactional cost, while the higher TER is a running cost. If you run the numbers for long enough, running costs will lose in almost every case.

To give you another perspective, divide the R17 million by the 300 rule. This shows that Art could have R56880 a month to spend in retirement if he switches to the ETF now. Not switching from the original fund means Art would have R42487. I’m not sure about the rest of you, but if I was Art, I wouldn’t give someone R4.3 million of my hard earned cash and then live with R14000 less every month into my old age.

What do you think Richard er I mean Art?

Give the calculator a try here. Take note that the calculated market returns exclude inflation, so the results you see are all in today’s money. You’ll also notice that you can mouse over the graphs to get instantaneous readings.

*Not all unit trusts are bad, some are based on passive index investing like the majority of the Vanguard funds, and locally like many of the Satrix and Sygnia funds. These are good unit trusts, and should cost similar amounts to a typical ETF.

**Interestingly an ETF can actually beat he index, giving you what’s known as Alpha. This doesn’t happen often, but in the case of the ETF I use, the Vanguard World fund (VWRD) this has actually been the case. By keeping the costs ultra low, and by using offering the shares they own to shorters, they’ve actually managed to generate profit that’s higher than their expense ratio. Since inception the fund has returned 10.76% while the index has returned 10.74%. I know it’s a tiny bit extra, but when you compare it to the massive relative losses the active funds have made it’s outstanding!

Do you still own (expensive) unit trusts?

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  • grahamcr

    Hi Patrick – this is not an attack on your article, but a few observations that don’t seem to gel. So let me start with some imponderables. Art is 29 and a bit years. I know he is fictitious as you said so, so maybe address some of the following questions/statements
    $ When did he start work – age would suffice
    $ What salary did he earn on commencement of his working life
    $ Did he gain a university degree after leaving school
    $ If he did has/did he or a family member liquidate his university fees
    $ If he did go to university at what age did he start and finish his degree
    $ Given that if he didn’t go to university he could have started work some 11 years ago – which would make it about 2006 ore maybe a bit earlier
    $ given that he has been putting aside R10,000 per month lately he would have made a capital injection of R 120,000 over this period into his investment
    $ Given that he would have started at a much lower salary 11 years ago he would not have been setting aside R 10,000 per month
    $ During 2006/2007 the markets fell quite significantly (about 40% I recall on our markets depending on where you were invested) and took most of 2008 to 2009 to recover to a level of about 80%
    $ Given the above scenario surely his portfolio would have similarly have been affected by this “market crash” how did he do in the recovery phase because my unit trusts took significantly longer to return to acceptable levels
    $ Our local market peaked (Alsi 55,298.92 on 24/4/2015) and has been on a downward path since then. Zuma 783 ministry changes have not helped
    $ So my real questions are how did this Artful Dodger manage to cross the magical R 1 mill threshold in the space of 11 years (and a bit) given the rather putrid returns achieved by U/T’s since 2005. And also how did he fund the purchase of later model car (loan or cash) and since there is no mention of a wife I suppose he is since and living in a flat which is unfurnished as their is no mention that he acquired assets (furniture and fittings) in his abode. Maybe his parents funded him – a sort of early and spread inheritance.
    I also get the sense that Art is a bit of a hermit as he seems to not have much of a social life
    So many imponderables which maybe you may choose to address, but, is not necessarily a challenge to elucidate

  • Сергій

    I think you’re loosing the point. This 1M is just a nice number to show effect of fees. And to get to it you should behave in a certain manner (not buying houses or new cars etc.)

  • grahamcr

    That’s a cop out – when dealing with monies or finances you need to deal with realities of the investing scenario. If your argument is around fees and its destructive nature on real returns then one can show it graphically by plotting the declared income stream and the real fees consumption stream. similarly you could merely plot the internal rate of return on the investment and then show the resultant effects of the fees as line versus (for instance) the Alsi or the Top 40 lines over a defined period
    When investing seriously warm and fuzzy doesn’t cut it

  • Berghaan Botha

    Nice analysis, but truly in investing there are no realities except the current portfolio stats. The rest is a vast amount of accurate or inaccurate data that you can cherry-pick or interpret any way you prefer to arrive at your reasonably expected outcome.

    R1M is a nice number to get his point across. If he did not explicitly explain how he got there, just pretend that R500k of that sum was a gift from somewhere. You can plug in your own numbers in any case.

  • Hey GCR, I know you like the details, I’ll try to answer as many as I can:
    $ When did he start work – age would suffice. Age 17, as a waiter in a very busy coffee shop while studying apparently.

    $ What salary did he earn on commencement of his working life – No idea.

    $ Did he gain a university degree after leaving school – Yes

    $ If he did has/did he or a family member liquidate his university fees – Very fortunate to have parents covering the bill

    $ If he did go to university at what age did he start and finish his degree – 18 through to 20, a 3 year degree completed on time

    $
    Given that if he didn’t go to university he could have started work
    some 11 years ago – which would make it about 2006 ore maybe a bit
    earlier – Yes, but studying and working are not mutually exclusive.

    $ given that he has been putting aside R10,000 per month
    lately he would have made a capital injection of R 120,000 over this
    period into his investment – Yes

    $ Given that he would have started at a much lower salary 11 years ago he would not have been setting aside R 10,000 per month – Correct

    $
    During 2006/2007 the markets fell quite significantly (about 40% I
    recall on our markets depending on where you were invested) and took
    most of 2008 to 2009 to recover to a level of about 80% – Yes, but fortunately not a large amount was lost at this time, of course the percentage was high, but not as much was invested. Salaries really take a leap after about two years, so the bulk of the investing was in the super bull market that followed 2008.

    $ Given the
    above scenario surely his portfolio would have similarly have been
    affected by this “market crash” how did he do in the recovery phase
    because my unit trusts took significantly longer to return to acceptable
    levels – see above

    $ Our local market peaked (Alsi 55,298.92 on 24/4/2015) and
    has been on a downward path since then. Zuma 783 ministry changes have
    not helped – The fund he used claims 16% since 2006. That’s pretty much in line with the index. R5k per month for 11 years at 16% crosses the R1m mark, so it’s definitely doable.

    $ So my real questions are how did this Artful Dodger
    manage to cross the magical R 1 mill threshold in the space of 11 years
    (and a bit) given the rather putrid returns achieved by U/T’s since
    2005. And also how did he fund the purchase of later model car (loan or
    cash) and since there is no mention of a wife I suppose he is since and
    living in a flat which is unfurnished as their is no mention that he
    acquired assets (furniture and fittings) in his abode. Maybe his parents
    funded him – a sort of early and spread inheritance. – As above it’s doable without an inheritance, though you could say getting your university fees paid is a massive boost. Cars should be bought cash, something I’ve always done too.

    I also get the sense that Art is a bit of a hermit as he seems to not have much of a social life
    So many imponderables which maybe you may choose to address, but, is not necessarily a challenge to elucidate

    -I know of another non hermit with a child who also crossed the R1m before age 30. It’s quite doable as long as you keep expenses well under income and start early enough. Many people, myself included work while they’re studying which helps enormously.

  • grahamcr

    Thanks for the responses Patrick – my only concern is that most of the achievements are hypothetical and not necessarily based on a live case study – but then again you don’t want to incur the wrath of your wife all over again, lessons learnt are to be cherished

  • Lupa

    If he moved his money out of the UT into something with a more palatable fee structure in small bites instead of one large chunk surely he could ameliorate the CGT pain at least somewhat.
    I mean, if he stops funding the UT today, and starts moving the money out in smaller quantities to take advantage of the 40K (I think) that you get free of CGT. Obviously to only move 40K per year would be ridiculous, but doing a few hundred thousand at a time should make a difference to the tax burden. There must be an optimal formula there somewhere…

    I was just considering this question for moving some of my own money, but since the total sum was smaller, and the fee situation not nearly so rosy, the actual amount of growth liable for CGT was small enough that it made sense to just do it all in one go.

  • Shane

    Graham, maybe read that Title again …

  • Joe

    From people I’ve studied with, professionals with a net worth of R1m at age 29 is very doable.

  • grahamcr

    Shane – have done so – and your point is?

  • grahamcr

    I presume these people all did it from a zero base, or, did they get a leg up from parents/relations?

  • Francois Cassie Carstens

    Patrick, I really like your articles, no two ways about it. You inform and enlighten us and that is much appreciated. To me all these saving plans and ideas are unfortunately, pie-in-the-sky stuff. That is why I can understand where grahamcr is comming from. I read this article and I see that Art will have R56880 in 30 years time to spend per month. Cool. Do you and everybody else relies that in 30 years time, R56880 will most probably have the buying power of 10 grand today and we all know that with 10 grand, once you deduct tax, medical aid, municipality, insurance long term and short term and all the other “must have’s” you will barely be able to survive? Oh of course the investment websites say you have to increase your saving by at least inflation every year. Ja, but what if, the average yearly increase that you get at your job, is below inflation (+-6%) and far below the CPI (Consumer Price Index +-15%) and the cost of living (food and all that other monthly stuff) goes up by x every year far higher than your increase if you got one? What then? I read a lot of financial websites and would you know, I still have to find a single investment website that lays it out to the last nitty gritty of real life. I think nobody want’s to put up a calculator like that because the last line will read “Sorry sir, you are screwed. Bye Bye”

    Sorry guys. I am rambling along here but just putting my thoughts to “paper”.

  • Hi Francois, I’m glad you like the articles, and I think a lot of the readers find your comments useful. When working with inflation there are two ways to deal with it:
    1) Increase growth with inflation, and then calculate back what your value would be in “today’s money”. I do this in the compound interest calculator on the site; Or
    2) Increase growth without inflation (I used 6.8% growth over inflation here which is the market average), that way what you see in the calculator is what it will give you in buying power in real life when the time comes. That’s how this calculator and the FIRE calculator work.

    That means that the R56880 isn’t actually what Art will get one day, in reality it will be much higher, but it’s buying power will be the same as R56880 has today.

  • Francois Cassie Carstens

    Patrick, there is something that I would like to share and it is driving me nuts and it is very much related to investing. Okay, I’m an amateur futures trader. Being that, I know that to trade 1 futures contract you have to put down a “deposit” (margin) of R32000 and then I trade for 10 bucks a point. Okay, now for the story. I asked my financial planner, if I gave him R1 000 000 bucks and he invested it for me, how much could I get as income per month right now? He said conservatively about R6400 per month. So at 10 bucks a point, R6400 /10 = 640 points. So the guy that is investing my million bucks has to make 640 points per month and he gets 22 working days to do it. So 640 points divided by 22 working days gives me 29. So that superman trading with my money has to make 29 points per day so that I can get 640 points that would give me R6400. Cool. We move forward.
    I started doing some calculations. R1 000 000 bucks divided by R32000 would give me 31 contracts to trade. And here I fell off my chair and started swearing at these investment guys. If you trade 31 contracts you basically have to make 1 solitary point per day! 31 contracts x 1 point x 22 days = 682 points = R6820.00 per month. Do you see that. As a professional trader with the best systems and information, he has to make 1 point per day and then he has made the R6400 that he has to give to me for the month and then he charges me fees!! Now just to give it some more perspective. I know that a scalp = 38 points and there is a lot of them in a day, but lets just take one scalp since a professional trader at the Sanlam’s and Old Mutuals of the world could easily make 1 scalp a day – 31 contracts x 38 points x 22 working days in a month = 25916 points and that at 10 bucks a point = R259 160.00!!!

    So since I am not getting R259 160 per month, I have to ask. What the heng are they doing with my million bucks after they have made the 1 point that is required to pay me R6400 for the month? Patrick what I am saying here is that the traders / investor okes that work with our money, are giving us pennies in return on our investments.