Q: Under present conditions, what rates should financial advisers be charging? I saw somewhere recently that said rates should be lower than 1 per cent. Is there any substance to the suggestion that charging a rate against the principal rather than the returns is grossly unfair. There is currently little incentive for financial advisers to get the best return for their clients. If their income relied on the returns they could get for their clients, then they would more likely earn their commissions.
A: This is an interesting question and one that has been asked regularly over recent years. The amount that you should pay a financial advisor should of course be consistent with the amount of ‘value’ you feel you are getting for your money. In theory, this should apply, however the adviser calculates his fees. If you feel you are getting good value for what you pay, you will typically not argue about fees. There is a very interesting debate about what represents ‘value’ and advisors have different ‘value propositions’. There is a famous and very apt adage applying to this issue which goes “price is only a concern in the absence of value”!
Clients often perceive value differently from advisers. Some advisers and clients only see value being delivered in the rate of return they achieve on the money invested. If this is the only value proposition, then as rates of return fall the client will perceive lower value being delivered.
In the current climate when rates of return on almost all asset classes are low, a charge of 1 per cent on the investment portfolio can seem disproportionately high, particularly when compared to the income earned on the portfolio. If you have the perception that this is the only value that advisers deliver, then I agree that 1 per cent is way too high.
But let’s talk a bit more about what is happening in the financial services industry now as not all advisers charge for their services the same way.
For many years, the most common way for financial advisers (like fund managers) to charge for their services was a percentage of the money they help to manage for the client. A charge of 1 per cent for the first $1 million is not uncommon. Typically, the percentage charged will decline as the amount of money in the portfolio increases beyond $1 million. The theory is that a percentage-based approach aligns the interests of both the adviser and the client.
But in my opinion, this is definitely not always the case. In fact, this approach, in my view, has a number of shortcomings in a professional service setting. A classic example is that in terms of delivering the normal range of financial planning services, the amount of time involved in looking after a client with say $1 million in funds is virtually identical to that for a client with $2 million in funds. However, under a percentage-based system the $2 million client will pay twice as much for effectively the same services. Alternatively, what about a younger client who has little to invest but needs a lot of help, for example, with tax, mortgages and insurances. A percentage-based fee does not work in these cases.
Alternatively, there is an increasing proportion of financial advisers who have moved away from this percentage-based approach. They choose instead to use a flat dollar amount that is calculated based on the nature and range of services delivered, the complexity and time involved in managing client’s affairs and only partly on the amount of money that is being managed.
I personally prefer this approach for fees as it reflects more accurately the time, cost and expertise involved in delivering services to clients. I strongly believe that a good financial adviser can deliver a very valuable service, which is only partly attributable to the money in the investment portfolio. As previously indicated, some clients may need a number of financial services but have little money to invest at the time. A good advisor will deal with a wide range of issues that can change significantly over time, including but not limited to:
If all of these issues are being effectively managed for a client over time, substantial value can be delivered and the way in which the fee is calculated should be a matter of negotiation between the client and the adviser. As previously indicated, I feel that a dollar-based fee which reflects the type of services and complexity of a client’s circumstances is more appropriate in general than a percentage-based fee.