Sunday, July 08, 2007

Expense ratio on long term savings

If you invest regularly for many years, to accumulate savings for your retirement, the amount that you can get on maturity depends on:

* the yield of the underlying assets of the fund (insurance fund or unit trust)
* the charges that are taken away from the earnings

If you invest in a well diversified fund of equities and bonds, you can expect an average return of 5% per annum (during a low interest rate environment).

You have the following options:

* invest in a low-cost unit trust with an expense ratio of 1%
* invest in a low-cost endowment plan with a expense ratio of 1.5%
* invest in a high-cost endowment plan with an expense ratio of 2.5%

An endowment plan has a higher ratio, compared to a unit trust, as it has to provide for the death benefit. I estimate it to be an additional 0.5%.

The difference in expense ratio between a low cost endowment and a high cost endowment is the commission that is paid to the agent. Most endowment plans in the market pays high commission to the agent. I estimate that it will add an additional 1% to the expense ratio.

This is what you can get, by saving $2,000 yearly for 30 years:

Plan Expense Net Maturity
margin yield amount
Unit trust 1.0% 4.0% $136,200
Low cost Endowment 1.5% 3.5% $105,000
High cost Endowment 2.5% 2.5% $ 89,000

For a 30 year investment, the difference in the maturity amount is 18% (ie $105,000 compared to $89,000).

Lesson: If you to invest for the long term, look for a unit trust or endowment plan that have a low expense ratio, so that you can earn a better maturity amount.

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