Most high cost products can reduce you yield by as much as 2%, giving you a net yield of 3%. This 2% yield may appear small, but over a 35 year period, it could take away 34% of the accumulated amount, giving you a net amount of $373,000. You are left with a net gain of only $163,000. The amount taken away from you, representing the reduction of 34% is $196,000. In other words, you are left with less than half of the total gain.
It is important that you find a product where the reduction in yield is as little as possible.
If you invest directly in shares, you will not suffer any reduction in yield, but you will need to monitor the shares and make sure that you collect the dividends and rights issues. You may also suffer a big loss, if the particular business performed badly.
To avoid this risk, it is better to invest in a unit trust where the investments are professionally managed and and you enjoy diversification. However, the charges for most unit trust is 1% per annum, which is rather high. The fund manager will tell you that he can add value by picking the good stocks that will perform better than the market, but studies have shown that most fund managers are not able to generate this value.
You can invest in an exchange traded fund, which is benchmark against the stocks comprised in the market index. An example is the Statestreet Trakker fund, commonly known as the STI ETF. The management fee is 0.3% per annum. This is a low charge, compared to unit trust.
Read this table to see the impact of a reduction in yield on a monthly savings plan over a number of years.
Tan Kin Lian
8 comments:
How about the Home Fund by POSB? The charge is 1%
I look at it this way, buying shares directly also incurs "reduction in yield":
- the buy-sell spread
- the trading commission
Of course, that'd certainly be much less than that on unit trusts and much much less than that on regular premium policies.
In a buy-term-and-invest-the-rest personal financial planning model, the entire term premium costs are also "reduction in yield" on overall portfolio returns.
Mr Tan.
Would index futures be a better investment than exchange traded funds? Of course with the assumption that both are tracking the same index.
For index futures, u come out with about 5% as margin. u can put the other 95% in savings account and earn a little interest. When there is margin call, just transfer from savings account to the futures account. So effectively there is no leverage. Effectively no need to pay the 0.3% ETF mgt fee and can earn a little extra from the savings account.
There is a cost involved in rolling over the futures contract, however, but I am not too sure whether that will erase off the positives.
What is your view?
Index Fund is fundamentally reflective of the market tracked, i.e. it actually holds the a portfolio of the component shares.
Index Futures is speculative, it's a derivative based on the Index tracked plus expectation sentiments quarter-to-quarter. It holds nothing fundamental, just a speculation on the expectation of next quarter.
Also, because of the high leverage, e.g. $5k to hold $100k positions, a sudden jerk upwards could deliver a windfall, whereas a sudden jerk downward could wipe one out completely.
The thing which is missing from index futures is the money from dividends. With index futures, you earn no dividends.
You also need to add in the cost of carry. The value of index futures for say December is usually higher than the value of index futures in November. This is to reflect the value of the leverage in the instrument.
If you apply this strategy, you will need to keep a significant portion of the 95% in a very liquid form (e.g. savings deposit) in order to meet margin calls. These earn very low interest as compared to a fixed deposit. As it is significantly lower than the cost of carry, you therefore lose money every time you deploy a roll over.
Finally if you are a small investor, you will mostly likely have to do the roll over manually in order to keep costs down. If you make a mistake with the rollover (e.g. you forgot the expiry date, you queue two legs of the order and only 1 got executed), then you will have to bear full cost of the mistake.
All in all, you need to be a fairly experienced and sophisticated investor to deploy this strategy. If you add it all up, you will probably enjoy some savings although the amount is not likely to be fantastically huge if your ETF fee is only 0.3%.
Wholelife, endowment and regular ILPs have the highest charges as much as 2.5 years of your premiums. They have regular yearly policy fees too. Is it wonder why these products have very poor return? If anyone buying them for saving you will end up as suckers because after 25 years or more your 'saving' return is negative in real term.
Dear 29 Sep 5:48 PM
I understand what u r saying. I have another question. For ETFs that track stock indices, are they benchmarked against the index or the adjusted index that takes dividends into account? If it is the later, then isn't the fund manager allowed to make a tracking error within the average dividend rate of the component stocks in the index?
The common approach is to benchmark aganst the index. The dividends collected is used to offset the expense chages. So far, I have not seen any ETF's adopting benchmarking against an adjusted index although we cannnot rule out that some smart marketing person might do this and bury it under some incomprehensible financial gibberish.
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