Tahoe Market Pulse: Financial adviser fees – a rip-off, or justified?
There are a lot of good commercials for financial planners and advisers. One of my favorites has a disk jockey posing as an adviser in front of prospective clients.
He uses catch phrases like “asset allocation” in order to win their trust. That sales pitch works as long as his knowledge is one level above the prospective clients’.
In a commercial from Charles Schwab, a child asks his father if his adviser refunds his fees if he isn’t happy. Promising to refund fees must be working because TD Ameritrade announced they will refund fees as well. Is this offer as good as it sounds? Not so fast.
Here’s the problem: Investors often think that they’ll get a refund on their lost money. That won’t happen. It’s only the adviser’s fees that will be refunded.
Let’s look at a hypothetical example. Suppose an adviser lost 15 percent in one quarter on a $500,000 account. That’s a $75,000 loss. Ouch.
The typical adviser charges about 1 percent of assets per year so the quarterly charge is $1,250. So on the $75,000 loss the refund would be $1,250. Not exactly exciting. I should note that Schwab and TD Ameritrade will only refund fees if you choose one of their approved advisers.
There is another fee structure that some investors prefer that rewards the investment manager with a profit incentive fee. The pitch is that the adviser receives more income when he does well for his clients.
This incentive is most often seen in hedge funds. The problem with this structure is that it gives the investment manager an incentive to take more risk. If the increased risk leads to higher returns then everyone is happy.
But what if the bets don’t pay off? The manager must recoup the losses before he can start reaping the incentive fee. If losses are large enough to where recovering them in a timely manner is unlikely, then that manager often chooses to close the fund and start another one with a different name. I’ve seen it many times.
Overall, fee structures should be simple and straightforward, and advisers should be able to explain their fees in one sentence. It is up to each investor to determine whether the fee is acceptable.
David Vomund is an Incline Village-based fee-only Registered Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients may hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.