# Return on investment?

Discussion in 'Investments' started by Patgdirector, Dec 30, 2016.

1. ### PatgdirectorRegistered User

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I have been investing with an Irish Life Assurance company since May 1994. I started off in 2004 paying €342.83 twice a year and in 2016 I paid €955.12 twice a year also. It goes up by 5% each year to take in to account inflation.

According to my calculations I have paid in €25,361.54 and it is worth €35,840. I know it is worth 40% more than what I have put in but taking in to account the over 20 year is this a good return? What is the % annual return?

Many thanks

2. ### dub_nerdFrequent Poster

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Last edited: Dec 30, 2016
Your own figures don't quite add up. If your first half yearly payment is 342.83 in May 1994 and it goes up 5% a year, your 22nd May payment (that is, the one in May 2015) will be 955.12 :

$a_n=ar^{n-1}\ \ \Rightarrow \ \ n=\frac{\log{a_n}-\log{a}}{\log{r}}+1=\frac{\log{955.12}-\log{342.83}}{\log{1.05}}+1=22$

... where a is the initial payment amount in year 1, an is the amount in year n, and r is the common ratio of the geometric series i.e. 1.05 for 5% growth. At the end of 2015 you will have contributed the following amount which we get by summing the series, bearing in mind there are two payments per year:

$\sum_{i=0}^{n}a_i=a\frac{1-r^n}{1-r}=(2\times 342.83)\left( \frac{1-1.05^{22}}{1-1.05}\right )=26,401.49$

This is greater than the total payments according to you by something over €1k and is at the end of 2015, not 2016. Maybe you can figure out what is wrong from your figures. But just to show the growth calculation, assuming your €35,840 value applied at the end of 2015, we just look for a different rate of growth that would have produced that:

$\sum_{i=0}^{n}a_i=a\frac{1-r^n}{1-r}=(2\times 342.83)\left( \frac{1-r^{22}}{1-r}\right )=35840$

$\Rightarrow 1-r^{22}=(1-r)\left( \frac{35840}{(2\times 342.83)}\right )$

$\Rightarrow 52.271r-r^{22}=51.271$

$\Rightarrow r = 1.07524$

That is, the growth rate was 7.524% of which 5% was accounted for by your increased payments, so the growth produced by the fund was just over 2.5%. Obviously this is an average and the actual growth rate will have varied from year to year.

Is this a good return? I don't know much about it but looking at historical S&P 500 figures I see it grew by an annual average of 7.37% between the end of 1994 and the end of 2015. On that comparison, it doesn't look very good. Had you got the S&P 500 rate of growth your fund would be worth €58,637. I presume your policy had some sort of life cover component which you seem to have paid pretty dearly for. Perhaps one of the finance gurus here can comment.

Last edited: Dec 30, 2016
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3. ### Duke of MarmaladeFrequent Poster

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Last edited: Dec 30, 2016
Thanks to the eponymous dub_nerd for crunching the numbers (deeply impressed).

Is it a good return? I presume you mean compared to alternatives. Need to know a lot more to answer that. It was probably a balanced fund so you would have been largely protected through the various stockmarket upheavals of the period so a straight comparison with an equity index is probably not appropriate.

Without actually checking I would be fairly confident that it comfortably beat saving in a bank deposit. On the other hand if you could have channelled the money to paying off a mortgage that might have been a better course, but I can't be sure.

A key element is taxation. If this is not a pension policy then it is one of the old style internally taxed funds. If that is the case then your return is after tax. That makes a big difference. By benign neglect these old style funds (no longer available) are taxed at 20% whilst the newer style funds are taxed at 41% albeit only when you encash (i.e. you get tax free roll up until then). Nonetheless you are on to a good thing and I would not be getting out or reducing my contribution unless I had to, in fact if allowed I would ask them to increase my contribution

Yes, life policies can be costly. As a rough guide you have probably lost 1.5% per year to costs i.e. about a third of the gross return on the fund before taxes and charges. Though on an ongoing basis the costs might be half of this (no more brokerage costs, I hope) so given the tax advantages I would hang on in there.

Last edited: Dec 30, 2016
4. ### PatgdirectorRegistered User

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21
Thanks for the response.
Looked at my figures again and went back over all the payments and sorry started in May 1995 with €342.83 in May and €342.83 again in December. 1996 was €359.97 in May and December and so on..
The life cover is very poor just €2,000 or even less if I kick the bucket...was only 25 at the time and not interested in life cover just savings.
So in April 2016 was worth €33,733.10 with €24,406.42 paid in.
So not sure how that affects the return on investment..

I took this out when I started my first job after college and the life company in question pulled as master stroke when you hired the trainer of the local GAA team and he signed up all the lads...he signed up a lot of people.

Correct Duke it has the 20% tax so that is why I am not sure about cashing it. The house I am living in is paid off But I have just purchased a new primary residence so will be renting the old one. So the new house has a 3.3% mortgage rates so should I use the money from here to put against it?

5. ### Duke of MarmaladeFrequent Poster

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Last edited: Jan 3, 2017
From a purely arithmetic standpoint the question is: will your fund earn more than 3.3% p.a. after taxes and charges? Given the favourable tax treatment, 3.3% is not a big ask (but not a breeze either); your life company would probably illustrate that you will beat this rate, notwithstanding that you have failed to do so for the last 20 odd years.

From one lens you would actually be running a partial Endowment Mortgage in keeping the policy along with the mortgage, and these have been thoroughly discredited when used 100% to fund a mortgage. But at these levels there is a bit more flexibility in keeping your "nest egg" rather than cashing it in and paying down your mortgage. Of course, paying down your mortgage saves you 3.3% p.a. for certain whereas keeping your life policy runs a risk of a fall in values; there are those who feel current markets are artificially high because of Central Bank interference through QE and that a correction is due, but no one can tell.

On balance, though, the sums are probably not enormous in your overall context and you will probably prefer to keep up the policy esp. given its favourable tax status. It's a personal choice - not a slam dunk either way.

On a technical point, my guess is that you are in a mixed (aka balanced, managed) fund with some exposure to government bonds. It seems to me that this aspect of your investment is sub optimal in that you are earning at best 2% p.a. on the bonds whilst you are mortgaged at 3.3% p.a. To me, if you do decide to keep up the policy I would go all in and switch funds to a full equity exposure.

I sense that you are disappointed in your return. You would have been illustrated net returns at least twice those you have enjoyed. But I don't think you should be kicking yourself (or your life company or advisor) in having missed out on some super alternative, you haven't. The world has changed. The inflation driven super nominal returns of the second half of the twentieth century are now a distant memory.

Last edited: Jan 3, 2017
6. ### dub_nerdFrequent Poster

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Ok, makes sense. Ran a quick revised calculation and the growth rate looks slightly better at 2.8% per annum. Still pretty rubbish in my opinion. I disagree with Duke. If that is the average when the S&P average was 7.5%, how's it going to perform in the current era of low returns? I presume considerably worse.

Been there, done that. In my case it was the local maths teacher and heard several similar stories. Fortunately I only stuck with it a couple of years before realising all the initial money was going to pay fees. It was a good early lesson. Ever since I treat every form of financial salesperson as a hustler at best.

7. ### Duke of MarmaladeFrequent Poster

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Pat you invested less than 3% of your 22K in 1995 so I am not sure how relevant is the growth in the US stockmarket from that date. Possibly more relevant is that the Irish stockmarket fell by 40% from its peak which happened about in the middle of your investing that 22K.

My recollection is that life companies at that time gave two illustrations, a higher one assuming growth before charges and tax of 8% p.a. and a lower one of 6% p.a. After taxes and charges these would roughly become 5% and 3% respectively. So you more or less came in on the lower illustration. I suppose that is cause for disappointment esp. if your GAA trainer told you to ignore the lower illustration as being the silly life company being too cautious.

However, note that long term inflation expectations at the time were c.5% (hence the premium increases on your policy) and that acual inflation has turned out to be much lower. So when you "inflation adjust" those illustrations they seem remarkably spot on.

IMHO you should not let the difference between your past return and the return on the American stockmarket since you took out your policy influence whether you should now cash it in and pay down your mortgage.

8. ### dub_nerdFrequent Poster

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Duke, I presume just because it's an Irish Life fund does not mean it's invested in the Irish stock market, so the ISEQ is no more relevant than the S&P. However, the S&P also fell 40% during the GFC so I take your point about the fund taking a hit late in the investment period. I ran the OP's numbers again using the actual S&P end of year numbers for each year instead of an average. I applied each year's S&P growth to the previous year's investment by the OP. Obviously this is still an approximation and uses an index that may or may not be relevant, but the numbers do come out closer to the OP's actual returns:

The OP got a valuation sometime in early 2016 so at S&P rates of growth it should have been somewhere between the two bolded figures at the bottom right. Allowing for fees etc. you could maybe argue that his actual value is not a bazillion miles off (although it doesn't look so great when you subtract the amount paid in and just look at actual growth). Perhaps the real lesson is that stock market investments are prone to serious episodic setbacks and are risky even over long time horizons (contrary to what I feel is sometimes portrayed on this forum).

9. ### Duke of MarmaladeFrequent Poster

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Last edited: Jan 5, 2017
Great stuff nerd I have taken your growth figures and made allowance for tax and charges. You will see that it comes in at even less than Pat enjoyed. However, I suspect your growth rates do not include dividends. If we allow for these we might get remarkably close - which of course will be a complete fluke for I guess Pat's fund was a million miles away from the S&P index

We do see in the figures that based on this example typical charges consumed about half of the net (of tax) growth available. The sums involved are small and we see that retail investment at these levels is scarcely economically justifiable, though it did beat bank deposits and state savings (I think). I shudder to think what the economics of low end retail investment is these days in such a low return environment, and with 41% exit tax