The reduction in yield is the difference in yields between the uncharged and charged projections. It is not simply equal to the sum of the charges present on the account. It is produced by following the FCA handbook which specifies how to calculate the figure; https://www.handbook.fca.org.uk/handbook/COBS/13/Annex4.html.
The illustration displays two reduction in yield calculations. One is for just product and fund charges, the second is for product, fund and adviser charges. For the product, fund and adviser charges calculation, the process is the same, however step 1 now allows for product, fund and adviser charges.
For the Product Charge and fund charges reduction in yield, this can be summarized as;
- Calculate the projected value (PV1) at the mid growth rate (A) allowing for the product; fund charges.
- Then project forward at the same growth rate this time excluding all charges, giving PV2
- Reduce the growth rate from A until PV2 falls to equal PV1. The resultant growth rate is B.
- The reduction in yield is then = A – B
- This is then rounded to the nearest 0.1%
- An account with a £100 investment, a growth rate of 5% pa, and a charge of 1% pa.
- The projected value at the end of year 1 would be; £100 x (1+5%) x (1-1%) = £103.95.
- So a 5% growth rate (gross of charges and inflation) and a 3.95% growth rate (net of charges) gives a reduction in yield of 1.05% (5% gross growth - 3.95% net growth).This would then be rounded to give 1.1%
- As can be seen, this is slightly higher than the 1% sum of charges. It’s closer to the sum of the charges multiplied by the growth rate 1% x 1.05, which is why the RIY is greater than the sum of the charges shown in the illustration.
For the product and fund charges calculation, when calculating PV1 the calculator uses the product and fund charge amounts from the main mid-rate projection, that also includes adviser charges. When there is an adviser charge, this main projection results in a lower projected value than a projection with just product and fund charges.
The result of this is that when the product and fund charges are percentage charges, a 1% charge in the main projection gives a resultant pound (£) amount that is less than 1% of PV1 value at the same point of time. This in turn means a 1% product and fund charge can result in a reduction in yield less than 1%.