How the Effective Annual Cost (EAC) impacts long-term returns in preservation funds

A preservation fund is a retirement savings vehicle which allows you to preserve your funds when changing jobs. These are the funds which have been previously saved in an employer-linked pension or provident fund. It will enable you to continue with your retirement savings and ideally avoid the temptation to withdraw any retirement savings early.  

You can transfer your funds to the preservation fund without triggering a tax event, provided that a pension fund is transferred to a pension preservation fund, and a provident fund to a provident preservation fund. The growth within the preservation fund will also be tax-free.  

The Effective Annual Cost (EAC) is a standardised metric which was introduced by ASISA in 2015. This allows an investor to view the total fees and costs associated with owning an investment over a one-year period of time. Even a small difference in the fees and the EAC of your preservation fund can affect the potential growth of your preservation fund over the long term.  

This article will look to break down the EAC, help you to understand and properly analyse the costs you might see charged on a preservation fund, as well as look at the impact of the EAC on your preservation fund. 

What is the Effective Annual Cost (EAC)?  

The Effective Annual Cost shows the total annual fees and costs associated with an investment product over a year. The EAC includes: 

Administration fees: These are the fees associated with the administration of the fund. This will include tasks and activities such as reporting, compliance and tax. 

Advisor fees: These are the fees charged by an advisor for their advice and services. An advisor might charge both an initial and an ongoing fee. 

Management fees: These are the fees charged for the management of the fund. 

Other fees: Other fees that you may see charged are fees such as early exit fees or penalties 

It’s important to differentiate between the EAC and TER of an investment. The TER is the Total Expense Ratio of an investment. This refers to the total costs associated with the management and operation of an investment fund. These costs include management fees, audit fees, custodian fees, legal fees and operational expenses, but they exclude all advisor and transaction costs. The EAC is the total expenses for the year, including advisor and transaction fees.  

A higher EAC may mean that there are less returns to be reinvested and allowed to grow and compound over time. A lower EAC might mean that you have more funds to reinvest and are available to potentially grow over the long term. However, the EAC of a preservation fund should be just one factor to consider when comparing service providers. 

How EAC impacts long-term preservation fund returns  

Fees are deducted after investment returns have been realised. If the fees are on the higher end of the spectrum, these higher fees will then need to be deducted from the returns, and this means that there are less available returns to reinvest and potentially compound over time.  

Lower fees will result in there being more returns to invest and potentially compound over time, which will then positively impact your preservation fund capital growth. The same concept is true for a high EAC versus a lower EAC. 

In terms of preservation funds, higher fees and a higher EAC can have a significant impact on the potential growth of your preservation fund. Remember, as you are not able to contribute further to a preservation fund, you are solely reliant on the growth of your capital. Costs are one variable which the investor has control over, unlike, for example, inflation.  

As an investor, you cannot change the inflation rate and have no control over it. It is therefore a wise idea to try and minimise fees and costs where possible. This means that there will be more returns available to potentially grow. Investors often accept high fees without even realising it, as a higher fee of, say, 3% may not seem like a lot. In the long term, however, we can see how fees impact potential growth. 

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As an investor, it’s important to realise the impact that a difference of 2% in fees can have on your preservation fund in the long term. A 2% difference in fees may not sound significant, but in reality, this 2% can have a significant effect on the capital growth of your preservation fund, especially when compounded over time.  

Fee Example: 

Let’s look at an example to show the effect of high fees on your preservation fund. We will be comparing fees of 3% with fees of 1%. 

Let’s assume the following factors: 

• Investment period of 30 years 
• Investment of R1,000,000 
• Return of 12% per annum 
• An inflation rate of 6% 

Example 1 (1% Fees): Real investment value is R3,985,000. 

Example 2 (3% Fees): Real investment value is R2,310,000. 

As you can see in this example, a 2% difference in fees when compounded over a 30-year period results in a difference of R1,675,000 in the real value of your preservation fund. Note that the above example is for illustrative purposes only, and actual results may vary. You can learn more about how fees impact potential growth here.  

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10X offers a transparent and low-fee offering with a focus on long-term results, aiming to obtain returns our clients can retire on. Our retirement product fees, such as preservation funds, are generally less than 1% for most products. This depends on the amount which is invested and the product which has been invested in. To find out more about our fee structure, visit our website or speak to our knowledgeable investment consultants.  

What is a Typical EAC for a preservation fund?  

The EAC values that you typically see charged in South Africa range between 0.5% to 3.5% and even higher. Index tracking funds typically have a lower EAC compared to more actively managed investments. This is the case because index-tracked funds usually choose a benchmark index, which they will try and mirror the performance of, like the S&P 500. They will then buy the same securities in the same proportion as that particular benchmark index. There is, therefore, not a lot of analysis or research that goes into this strategy, which may result in lower management fees.  

Actively managed funds, on the other hand, will make use of a fund manager who aims to pick the right stocks at the right time to maximise growth and beat the returns of the market. This approach involves a lot more research and trading, which increases the total costs involved. As an investor, you often have to bear the brunt of these higher costs. And then, you might have to factor in adviasor fees on top of this (which 10X does not charge).  

10X makes use of an index tracking investment strategy with a more active approach to asset management, always keeping long-term returns at the forefront. This allows us to be more cost-effective. You can read more about 10X’s investment strategy here. 

The role of asset allocation  

Asset allocation is an important determinant in the returns which your preservation fund will generate. As an investor, you ideally want to maximise the returns produced by your investment vehicle. This is even more important if you’re paying higher fees. Your returns would need to offset the higher EAC being charged on your preservation fund.  

As an investor, you can adjust your underlying investment portfolio by choosing from a selection of carefully curated investment funds, each with diversified asset classes and geared towards different investor profiles. The asset allocation refers to the mix of underlying assets in which your preservation fund is invested. This will usually include a mix of equities, bonds, real estate (property) and cash. The curated investment fund which you select should depend predominantly on your risk tolerance, financial requirements and the time horizons you have available.  

A younger investor with a higher risk tolerance may wish to include more equities in their portfolio. Equities are the most volatile of the asset classes but also have the potential to produce higher returns.  

An older investor who is more risk-averse may prefer a portfolio that includes more bonds and cash. Both bonds and cash add stability to a portfolio, but they are likely to generate lower returns over time. Equities have historically generated returns above inflation by approximately 7% annually over long periods (based on JSE All Share Index performance versus CPI from 1960-2020), though past performance does not guarantee future results.  

Diversifying across the asset classes can also help protect your preservation fund in volatile times. This allows you to potentially gain from good market returns in certain asset classes while mitigating against losses in other asset classes. You may also wish to diversify offshore and take advantage of any opportunities on offer in the international market. This will also add some protection against local market volatility and potential depreciation of the Rand. 

10X offers a range of carefully selected funds inside our preservation fund wrapper, each with a different mix of assets and, therefore, suited to different investor profiles. To find out more about the funds we have on offer at 10X, click here.  

How to find and interpret the EAC Disclosure  

Your EAC can be found on your investment statement. You should also be able to find your EAC on the service providers' online portal, as well as on their fund facts sheets. The fund fact sheets should be available on the provider’s website. When looking for the EAC, you would always look for the total EAC. This is always expressed as a percentage. The EAC is broken down into investment fees, advice fees, administration fees, and others. If you are not easily able to locate your preservation fund’s EAC, you will need to request it from your service provider.  

As a part of our suite of online tools, 10X offers an EAC calculator, which can be found on our website here. This allows you to compare 10X’s EAC with that of your current provider to better evaluate your options. 

Conclusion: EAC is key for your preservation fund  

As you can see, EAC plays an important role in the potential growth of your capital over the long term. A higher EAC can impact the capital value of your preservation fund. As such, it’s important as an investor, you are aware of the fees and the total EAC that you are being charged on your preservation fund. If you are not able to easily access this information or find it on your preservation fund statement, then you are advised to contact your service provider and request the EAC information.  

You should review these figures annually and make the necessary changes as you see fit. You will find that a small difference in fees can impact the potential growth of your capital when returns are compounded over the long term.  

As always, it’s important to view investing as a long-term game and choosing a provider with transparent and low fees will set you up well for retirement. If you have any queries regarding 10X’s preservation fund and the fees involved, have a chat with our investment consultants, who will be happy to answer any questions that you may have.