Your questions answered

WHERE TO INVEST FOR A PENSION

I am 72 years old and retiring towards the end of the year. I would like to invest R850 000 for a pension, because my employer does not provide a pension scheme. I have no debt and no dependants.

The money is in a fund that invests in South African money market instruments. I am not charged any fees.

Interest rates are rising, so I am looking for a fund that will offer a better interest rate than 7.52 percent. I am also concerned about the interest on my existing investment, because it exceeds the annual tax-free threshold of R34 500.

Based on the research I have done, it seems I should be investing in income and growth funds that seek to reduce risk and volatility and protect capital.

I am particularly interested in two funds:

* The Prescient Income Provider Fund, a multi-asset income fund that invests in local and offshore money markets, bonds, property, preference shares, inflation-linked bonds and derivatives; and

* The Coronation Balanced Defensive Fund, which invests in local and international equities, bonds, preference shares and property. The equities in the fund expose me to market volatility.

At my age, and with retirement looming, I don’t want to take on too much risk or invest in high-equity funds. I want to grow my capital and generate an income. I would appreciate your advice.

Name withheld on request

Braam Fouche, a financial adviser at PSG Wealth in Umhlanga Rocks, Durban, responds: At the outset, it is useful to clear up the misunderstanding that often arises over the difference between interest and the return on an investment.

Interest is the fixed or stable rate paid by a lender on a specific amount of capital, which is repaid when called for. Interest-bearing investments, such as money market funds and fixed deposits, are considered to have the lowest risk, because, in general, the capital is secure and not exposed to fluctuating asset prices. These investments also offer the lowest rate of return.

The return represents the total proceeds that can be achieved on an investment, and include interest, rent, dividends and capital growth. Various factors that pose risk affect the return, which at certain times may be negative.

To obtain a return higher than you can earn on an interest-bearing investment, you need to accept additional risk, usually in the form of volatility, which occurs in the equity, bond, property, commodity and currency markets. There is a direct link between the expected higher returns and the accompanying higher risk.

There are other interest-bearing investments that may serve your needs, such as government and corporate bonds, which offer better interest rates than money market or fixed deposits. Investors with small amounts to invest can access government bonds via RSA Retail Bonds. Each of these investments has different risk characteristics, which need to be considered.

You say you are concerned about the tax on your interest-bearing investment. However, I do not believe this will be an issue once you are drawing an income solely from your investments.

Apart from the interest-income exemption of R34 500 for over-65s, there are other tax breaks that benefit low-income earners. In the 2016/17 tax year, the tax threshold for over-65s is R116 150, while you are entitled to both the primary and secondary tax rebates (totalling R20 907). The medical tax credits for over-65s should also reduce your taxable income. Based on the information you have provided, it is highly unlikely that you will pay tax on your investment income in retirement.

Your current investment is yielding a decent, tax-efficient return of 7.52 percent a year without volatility. However, over the long term it will not offer much protection against inflation, particularly once you draw down a high percentage of it as income.

The only way to protect your capital against inflation is to expose a portion of it to growth assets, such as local and international equity and listed property. At 72 years of age, your investment horizon is more than 10 years.

Both the funds you mention incorporate limited risk to generate the out-performance you require.

The Prescient Income Provider does not have any exposure to equities, although it has limited exposure to listed property, which has the same risk characteristic as equities. A positive feature of the fund is its offshore component, which offers rand hedging. But in a low-risk fund, this itself can become a double-edged sword if the rand strengthens. In my view, because the fund’s exposure to growth assets is somewhat limited, you should not invest all your capital in it.

The Coronation Balanced Defensive Fund ticks almost every box required to generate income and growth for retirees. It offers limited, but sufficient, equity exposure, and can invest up to 25 percent in foreign assets. It has a long-term track record of out-performing its benchmark, and is specifically aimed at older and retired investors.

An investment strategy that you could consider is to split your capital between these funds, allowing for diversification and thus reduced volatility. I would recommend that you allocate more of your capital to the Coronation fund.

It may be prudent to phase in the investment, because events in the local economy point to increased volatility, which may also affect fixed-interest markets.

You may want to invest in the funds directly with the asset managers, instead of via an administration platform, in order to avoid paying platform fees.

ADVICE FEES ARE TOO HIGH

I will retire within the next two months and have consulted a financial adviser about how best to structure a monthly pension from my accumulated retirement savings. The quote was as follows:

* Initial plan: R5 000

* Implementation fee: R24 000

* Annual fee:

- Monitoring fee: 0.86 percent

- Platform administration fee: 0.28 percent

- Asset management fee: 0.67 percent – this could be higher, up to one percent, depending on the funds chosen.

Why should I pay this huge fee, which is more than two percent of my investment, whereas, if I choose a passive investment, such as 10X, I will pay an annual fee of 0.8 percent? At this fee structure and a drawdown of eight percent, my investment will have to grow by at least by 10 percent a year for me to break even, without taking inflation into account. This is highly unlikely.

Name withheld on request

Magdeleen Cornelissen, a financial adviser at PSG Wealth in Menlyn, Pretoria, responds: I compliment you on your decision to consult a financial adviser to advise you on the decisions you are confronted with, as well as for being bold enough to question the fees related to the implementation of the plan.

Your question touches on two important issues:

* Whether the work done by the financial adviser justifies the fees charged; and

* Whether a passive manager can provide you with similar performance at lower cost.

Regarding the fees quoted by your adviser, there are:

* The upfront fee for the work done to set up the plan; and

* The annual fees, to manage and administer the portfolio. Only the upfront fee and the monitoring (management) fee are allocated to the financial adviser.

In my opinion, the annual fees [quoted to you] are in line with the industry standard. What is debatable, however, is the upfront fee. You did not disclose the amount to be invested, so it is a challenge to provide a clear answer about the fairness of this fee. Generally speaking, however, it should not exceed 1.5 percent (excluding VAT) of the invested capital.

Why should you pay these fees if you can receive exposure to the market via a passive manager, possibly by not using a financial adviser? The answer lies in the trust and relationship that is built up between you and your adviser. Volatile markets bring out the emotional side of investors, often causing them to deviate from their financial plans. Financial advisers can steer investors away from making emotional decisions.

Regarding passive investments, although there is a place for them, you must remember that the goal of most passive managers is not to out-perform the index but to match it.

Based on the information provided, and taking into account your planned drawdown level, a consistently high level of performance will be required. Studies have shown that the role of the active manager becomes more relevant in volatile and bear markets. Furthermore, studies done by Morningstar indicate that the portfolios of clients managed with the assistance of a financial adviser, deliver, on average, an additional return of 1.5 percent a year compared with those of investors who do not use an adviser.

You must insist that your adviser adheres to the terms of your service-level agreement, because this forms the basis of the trust in your relationship.