We deal with a tax question almost weekly on The Fat Wallet Show. This is hardly surprising. South Africans in higher tax brackets are vocal about how little their tax contributions get them. Public hospitals and schools often lack infrastructure and aren’t well run. Those who can afford it resent subsidising public institutions while having to pay privately for the same services. Investors are taxed twice on each investment outlay and a third time for dividends received. Since the government can’t financially support pensioners, being as efficient as possible with your taxes throughout your working life gives you a better chance of financial security in retirement.
It is surprising that the reluctance to pay tax often doesn’t translate into a reluctance to pay fees. This might be an anchoring issue. A 35% payment to the government hardly seems comparable to a fund manager who only wants 2.5%.
However, explains John Bogle in The Little Book of Common Sense Investing, management fees can easily eat away more than half of your investment over an investment lifetime. If, for example, a market returns 8% per year and you invest in a fund that charges 2.5% per year, you only receive 5.5% of the market return. Before costs, R10,000 invested in the market that grows at 8% per year would return R469,000 over 50 years. Over the same time period, the same amount invested at 2.5% cost to the investor would only return R145,400.
Says Bogle, “The investor, who put up 100% of the capital and assumed 100% of the risk, earned only 31% of the market return. The system of financial intermediation, which put up 0% of the capital and assumed 0% of the risk, essentially confiscated 70% of the return – surely the lion’s share.”
While you’d be hard-pressed to find a South African willing to part with 70% of their money to pay for public services they don’t use, many investors still pay over 5% per year for old-school investment products like retirement annuities. The same R10,000 invested over 50 years would only return R44,733 at that cost. That is over 90% of your potential earnings in the pocket of your service provider for saving you the trouble of making investment choices. It might be time to have a closer look at what you’re paying for your investments.