Impact of a reduction in yield

If you save $500 a month over 35 years, your total savings is $210,000. If you earn 5% per annum during this period, you should get $569,000. Unfortunately, you will not get this full sum, as the financial institution will take away a portion of your gain to pay for their various charges, such as marketing, fund management, administration and profits.

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