Planning for retirement is one of the hardest financial decisions to make. The questions are daunting, and few have simple answers. When should you retire? How long will you live after retirement? Will you need 50%, 70% or 100% of your final salary each year to enjoy the retirement you envision? Financial planners refer to this as your replacement ratio, but behind the jargon lies a deeply personal question: what kind of life do you want when you stop working?
Only after grappling with these uncertainties can you begin to estimate how much money you’ll actually need. And then comes another surprisingly difficult question: where should you invest?
Most South Africans quickly discover that the retirement savings landscape is bewilderingly complex. There are pension funds through your employer, retirement annuities, provident funds and preservation funds.
Many people have multiple retirement accounts accumulated over a lifetime of changing jobs. Others have preservation funds they barely remember opening after leaving a previous employer. Unfortunately, choosing between these products is only half the challenge. The bigger problem is that they often invest in very similar underlying assets while charging dramatically different fees. This matters far more than most investors realise.
The fee effect
Retirement fees are deceptively small. An annual fee of 0.6% versus 3.5% doesn’t sound like much. After all, what’s a few percentage points? Over a working lifetime, however, those percentages become one of the biggest determinants of your eventual retirement wealth.
Consider two investors. Both contribute exactly R5,000 every month for 35 years. Both invest in funds that perform equally well over the long run, with an annualised gross return of 8% per year before fees. The only difference is what they pay in annual costs.
The first investor pays an effective annual cost of just 0.6%. The second pays 3.5%. After fees, the first investor earns approximately 7.4% per year, while the second earns only 4.5%.
The impact of higher fees is considerable. After 35 years, the investor paying 0.6% accumulates roughly R10.5m, while the investor paying 3.5% accumulates roughly R5.5m. The higher-fee investor finishes with almost R5m less, despite saving exactly the same amount every month and investing in markets that performed identically.
Look at it another way. To reach the same retirement balance as the low-cost investor, the person paying 3.5% in annual fees would need to save R10,317 per month – more than double – for their entire working life. That’s money that could otherwise have been spent on raising children, paying off a home or simply enjoying life. Fees don’t just reduce returns; they change the amount you have to sacrifice every month for decades.
Alphabet soup
Part of the problem is that retirement fees are rarely presented in a simple, comparable format. Instead, investors encounter an alphabet soup of disclosures.
There is the total expense ratio (TER), which captures the ongoing costs of managing a fund. There is the effective annual cost (EAC), which combines investment management fees, administration costs, advice fees and other charges into a single annual figure. Last, there is reduction in yield (RIY), which measures how much annual investment performance is reduced because of fees and costs. Each measure serves a purpose, but for ordinary investors they often create more confusion than clarity.
The question people actually want answered is remarkably simple: how much of my investment return disappears in fees every year? The industry has made progress in improving disclosure, particularly through EAC reporting, but meaningful comparison remains harder than it should be.
No-one knows what markets will return over the next 35 years. No-one can consistently predict which active fund manager will outperform over the coming decades. Economic cycles, interest rates, politics and technological change are all outside an investor’s control.
Fees are different. They are known upfront. Every rand saved in costs remains invested, earning returns year after year through the power of compounding. This is why costs deserve far more attention than they typically receive.
The benefit of low-cost passive funds
International studies have shown that, over long investment horizons, low-cost passive funds outperform the majority of actively managed funds after fees have been deducted. The reason is straightforward. Active managers must first overcome their own higher operating costs before generating any additional value for investors. Some succeed for periods of time. Very few do so consistently over multiple decades.
For investors looking for a low-cost retirement annuity, South Africa now offers several competitive options. Among them, Sygnia currently provides one of the lowest-cost retirement annuities available, where you can access its flagship Skeleton Balanced 70 Fund for an effective annual cost of 0.6% per year with a minimum monthly contribution of just R500.
The investment philosophy is equally simple. Rather than paying fund managers to attempt to outperform the market, investors own a diversified portfolio of index-tracking investments designed to capture market returns at the lowest possible cost.
Passive investing isn’t exciting. It doesn’t promise market-beating performance. But for investors with horizons measured in decades rather than months, low costs and broad diversification have repeatedly proven effective.
No rounding error
Planning for retirement will probably never become simple. You’ll still have to make difficult assumptions about when you’ll retire, how long you’ll live, how much income you’ll need and what kind of lifestyle you hope to enjoy. Those questions remain deeply personal, and no calculator can answer them with certainty.
But once you’ve worked through those uncertainties, there is at least one part of the retirement puzzle that has become clearer than it once was.
If two investments provide access to broadly similar markets, then costs matter enormously. Over a lifetime of saving, the difference between paying 0.6% and 3.5% a year isn’t a rounding error. It can mean millions of rand, years of additional work, or a very different standard of living in retirement.
South Africans have enough uncertainty to contend with when planning for old age. Choosing a retirement investment shouldn’t require guessing whether hidden fees will quietly erode decades of disciplined saving. The big questions about retirement will never disappear. Hopefully, knowing what to invest in has become just a little easier.
Thomas Brennan is a co-founder of Franc, a South African fintech company that helps people invest easily and affordably.
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- Retirement: control the controllables
Top image collage: Rawpixel; Currency.
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