The details that don’t come out in investment pitches

This article appeared originally in Gulf News: link to original article

Something ironic just happened. I have been arguing over and over again that there should be a private pension fund and that people must get decent education and training on how to better invest in those.
The idea is that private pension funds will provide a second or third layer to the public one, and so reduce the pressure on reforming the latter, but doesn’t make the reform obsolete though. So, anyway, I got a phone call recently from an insurance company offering me a saving, investment, life insurance, and pension plan.
Apparently, they are not the only ones, but they are now becoming more active in attracting individuals to join their plan. This article will provide basic knowledge in how to read the documents being offered, and how to make sure that you are fully aware of what you are signing up for. Let’s get started.
First, the amount that you would save on monthly basis. They will offer you anything from Dh1,000 a month to whatever amount that you can afford — or so they say. Other companies cap the amount at Dh5,000 while others cap it at Dh10,000.
For you to decide on that, you need to keep two things in mind — one, how much can you save a month? (Hint: will it increase if you underspend your income). And, two, what’s your target pension amount? The company will save and invest the amounts that you deposit every month at different rates of return depending on the risk that you are willing to accept — net life insurance premium and investment fund management fees, which I will get back to later.

When it’s time to retire, you can either withdraw the accumulated amount in cash, or be paid a monthly salary — this will last longer depending on how much you have been saving and the performance of your investments.
Second, the duration. Companies offer you the option to withdraw the cash at different points throughout, subject to the company’s own calculations and the amount you are saving. Some may allow it after five years, some after seven.
However, and talking generally, most companies allow clauses of emergency where you can withdraw cash under certain circumstances. General wisdom states that the longer you save and invest, the better your portfolio would look by the time you retire.
True to that. That though shouldn’t stop you from getting the cash out and putting it elsewhere if you find a better investment opportunity.
Third, the rate of return. When the company’s representative was speaking to me, he only quoted the highest rate of return and used it as pivot point to project my future savings and pension salary. The rate was 10 per cent.
If someone quotes you that, you should definitely question it for two reasons. One, sovereign wealth funds would kill for such a rate of return. Norway’s sovereign wealth fund, which is the world’s largest, averaged 5.8 per cent from 1998 to 2017, and that drops to 3.9 per cent after inflation and management fees (Norges Bank Investment Management).
Someone could argue that the rate of return for a large fund would normally be low to moderate. Yes and no. Relatively smaller funds could definitely generate higher rates of return, proven historically, and could even exceed the quoted 10 per cent, risk included.
Whatever amounts you decide to save, keep in mind your target pension amount above all. Also, the life insurance options means that you are covered in case you couldn’t work for whatever reason.
Finally, bear in mind please that the quoted 10 per cent will drop to 4.3 per cent after paying for the life insurance premium (from the saved amount) and after management fees.
Not only that, but no one here is taking inflation into account — lowering the rate of return further. The last thought that I want to leave you with: assuming low to moderate rate of return, how can money be made post premium, fees, and inflation?