How do you pay your adviser?on Wednesday, 23 November 2016. Posted in +CatererGoodmanPartners, Caterer Goodman Partners, Financial Advice, Investments
Do you know the different ways an adviser can be paid? Just last week we saw a new potential client (let’s call him Bob), who brought us his statements/contracts on a fund platform we haven’t seen much about before that he was using through another firm. It was being charged “aggressively” to say the least. It combined practically every fee possible. Each by fee was reasonable, but in combination the unnamed advice company operating in Shanghai had managed to capture somewhere between 70-80% of the market’s gains over the last 12 months. Not bad work if you can get it, although Bob was less than impressed. As you can well imagine. So what types of fees exist for an adviser to charge their client and what should you do about it? There are several different ways, so here is a quick guide.
- Management Fee. Your adviser charges a percentage of profits, say 1.5% per annum of the overall amount and they take care of the investment for you. Some correlation of interest since your adviser’s fee increases (in monetary value) as your portfolio does.
- Entry Fee. Up front commissions on placing money into a fund or investment structure. Sometimes the fees hit you on entry or are exit fees that decline over time to nothing. Suits funds that aren’t correlated with markets that are bought and held for years. Worth watching though since these fees can add up and encourage your adviser to “churn”. Believe it or not, some platforms charge an entry fee and then the adviser then is able to place into a fund that charges ANOTHER entry. Double entry costs. Does this seem fair?
- Profit Fee. The most common is 20% of the gain. To explain, say your portfolio goes from $100,000 USD to $150,000 (aka a profit of $50,000 USD). Your adviser or manager would be paid 20% of this $50,000 gain, (aka $10,000 USD). This does have the advantage of correlating investment returns with the adviser’s interest. The catch is that the manager of the portfolio is now incentivized to gamble, so you need a fair bit of caution and oversight to ensure the adviser sticks to the agreed risk profile.
- Hourly Consulting. Also known as “the fee-based only model” your adviser produces a report for an hourly rate and you implement. No conflict of interest, but you do need to execute it yourself which can take time and knowledge.
- Admin Fees. Some brokers charge administration fees for setting up accounts or for conducting trades for the client. These can range the gamut from the fair $5 per trade, to the unreasonable ($1,000 USD to establish and $50 per trade). As in all fees, the details matter a lot.
What is reasonable? We think that a market based investment should have a flat fee of say 1.5% per annum. That’s it. We do have clients that want us to take 20% of the profits, although we limit this to a handful of high risk clients. We don’t combine a 1.5% with a 20% management fee (although this is common for hedge funds). Multiple fees and combining an up-front commission with a management fee, and a profit fee is very unreasonable. Remember, the more you pay, the less you get to keep. What did Bob’s adviser do? Bob’s adviser was using a fund platform. The platform in question is itself sound. It can be used fairly and well. Or it can be used to screw clients. It is up to the adviser how they use it. Bob’s advice company charged him, an entry fee to the platform of 3% (not high), a management fee of 1% (not high), but also a profit fee of 20% (average). Each individual fee was OK, but already adding up to a bad deal. Worse was to come though. The profit fee was, however, weirdly, not based on the overall portfolio value, but on the gains of each individual fund. That’s utterly tricky nonsense right there. The adviser has no influence over individual fund performance, so why the performance fee? If a profit fee is paid, it should be paid to the underlying manager or based on the overall portfolio returns. Worse still Bob was unaware that at the fund level the adviser was placing Bob into commission paying funds ever 5-7 months and earning 5% for each placement. Bob was generating a lot of profit in his funds, but his adviser’s combination of fees ensured the advice company was able to siphon a large portion away. Pay peanuts, get monkeys? This saying is true of many things, and I’ve heard it used by advisers, but it’s simply not true of investment management or advisers. Many studies over a number of years have shown that the lower cost an investment strategy, fund or pension fund is, typically the higher the return. Strangely this advice is underreported by advisers and fund managers. Wonder why? Of course there is no guarantee of higher returns if you choose lower costs, but your odds are improved considerably. The only thing that higher fees guarantee is more earnings for your adviser/fund manager. Not you. “This advice is practically free!” There is never any such thing as free advice. Advisers who work on hidden commissions like saying their advice are free, and many clients like the illusion of avoiding fees or getting something for free. The ugly truth is that commissions are paid to the adviser based on the fees the fund/structure/product is able to charge. Higher commissions equal higher fees. Period. It is a simple linear equation that 10 year old could draw, so worth keeping front and center in your mind when talking to a new financial adviser. So what advice can you leave me with? What is your goal on fees? As a client, your goal on fees should be three-fold. To reduce them. To structure them so that conflicts of interest are reduced and managed. Finally simplicity. That’s why we think a basic 1.5% per annum with no added surprises is fair for all parties. If not a market correlated investment, then the simplest is a commission, but without any further management fees, admin or profit fees. In essence, ensure there is one fee and make it reasonable and simple and appropriate for your goals and holdings. Your Key Role? Managing fees/conflict of interest Understanding the charges and how this pays your adviser is your key role in selecting and working with a new adviser. It is vital to ask your adviser how he gets paid and exactly how much. Don’t be shy, although I understand some advisers don’t like to say. If you are happy to leave your portfolio with someone who is unable to say how much they earn from it, and how much you are paying, then…well you need to be very careful. Just ask Bob how careful you should be.#CatererGoodmanPartners, Advisory, Caterer Goodman, Caterer Goodman Partners, Caterergoodman, Charges, China, China Expat Money, Expat, Fees, Financial Advisor, Investment, Money, Owen, Owen Caterer, Shanghai, www.caterergoodman.com