Question: I am 28 years old and met with an insurance broker who suggested that I make a regular monthly investment. He gave me a quote on an investment that targets a return of inflation plus 2.5%. When I read through the document, I noticed that it has the following costs:

• Initial financial planning fee: 3.45%;
• Total investment charge: 1.62%; and
• Ongoing financial planning fee: 1.15%

Am I right in saying that even if my investment meets its targeted return, it will be worth less than I invested?

Answer: You are correct. The costs will consume any growth in the investment.

I often come across situations like this. In fact, I recently came across one worse than this, where the investment was funded via a stop order for which an extra 2.5% was charged.

There are a few things to look out for when investing, and I will run through them to help you ask the right questions.

Timeframe of the investment

If your investment timeframe is short, then the targeted return of inflation plus 2.5% would be fine. If, however, you’re investing for a longer term, then you should be looking for an investment return that is higher. I like to use the following model to set return expectations:

• Timeframe of less than two years = targeted return at inflation rate
• Timeframe of two to five years = targeted return of inflation plus 3%
• Timeframe of more than five years = targeted return of inflation plus 5%

The longer the investment timeframe, the higher your return expectations should be. The higher your targeted return, the greater the chance of your investment losing money over the shorter term, as investments go up and down all the time. However, over the longer period the investment should go up.

Fees

The fees on this investment are outrageous. The amounts charged are out of line with the potential growth on the portfolio and the value added by the financial planner.

In setting up an investment, the planner should have done a financial needs analysis for you. They should have identified the most appropriate investment structure and taken the current and future tax implications of your investment into account.

If your investment is incorrectly structured, you can end up paying far too much income tax. This is the most common mistake I come across when looking at investments that people have set up themselves.

A skilled financial planner would have added significant value here, and one would expect to pay for the service. The payment can be in the form of a consulting fee, or as an initial fee on the investment. The typical initial fee charged here does appear to be on the high side.

Your financial adviser should monitor your investment and recommend any changes. Again, this is a service that should be paid for. In this instance, 1.15% does seem to be on the high side.

As costs are easily measured, this element can become the main focus of an investment. By focusing solely on costs, you can miss out on growth. There are some portfolios I use that are expensive, but their track record is good, and the returns they deliver after costs significantly beat the after-cost performance of a cheap alternative fund.

We do not mind paying for a service if value is clearly added. In the example you cited, it does not look like there is any value being added and I would recommend that you get a proposal from someone else. DM

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R29.