There is something of a paradox built into the delivery of wealth management services today.
On the one hand, the main reason why you seek advice from a financial planner in the first place is that you want to get the absolute maximum out of the wealth at your disposal. This could be to fund business plans, aim for a comfortable retirement, or to secure a firm financial foundation for your children.
On the other hand, you probably lack the expertise needed to manage investment portfolios yourself, which means you have to pay someone to do the job on your behalf. Hiring a financial planner means sacrificing some of your wealth in order to get the most from it – hence the contradiction.
Most people are, however, quite happy to accept the principle of having to speculate to accumulate. If in return for a fee, your financial adviser or wealth manager helps you generate considerably more wealth than you would have done without their assistance, then there is clearly value in the service.
But what if you were to find out that you were paying proportionally much more than you should have for the service? Moreover, what if you were to find out that the way your fees were structured was potentially influencing your adviser/wealth manager to put their own interests above yours in the way they ran your investment portfolio?
Surely then the contradiction of allowing your wealth to trickle away in a bid to increase it would start to look problematic for you.
This is one of the issues with the fee structure traditionally used by the majority of financial advisers and wealth managers – percentage fees.
If you have decided to hire a wealth manager, the likelihood is you’ll have paid their fees as a percentage of the total amount you invested. The percentage looks and sounds pretty small – typically around 1% – which in the main keeps you happy. On the surface, a 1% / 99% share in your favour looks good.
But what wealth managers don’t like to advertise is how an apparently reasonably-sounding number like 1% can result in some very significant fees being paid out in the long term. If your investments perform well – which is what your financial planner is hired to ensure – you can easily end up paying out the equivalent of the original sum you earmarked for investment in fees, as your portfolio grows.
So, if you invest £1 million, given a percentage fee structure, you could easily end up paying out £1 million in fees from your portfolio to your financial adviser over a 30-year investment period (investing is often over two 30-year periods, 30 to 60 and 60 to 90). That’s £1 million which should have been part of your assets and used to help fund your retirement or passed on to your children.
What’s more, many wealth managers keep quiet about the fact that alternative fee structures exist. Structures like flat-fee arrangements, for example, where the amount you pay is set to a fixed rate annually rather than rising incrementally depending on how your investments perform. With flat fees, what you pay is always completely transparent and you know exactly what you are paying for the service.
Here are four reasons why anyone paying via percentage fees should consider switching.
A key issue with percentage fees is that the better your investments perform, the more you pay. This may be unfair because it essentially penalises you for getting the service you want.
Financial advisers and wealth managers argue that high-performing portfolios are the result of their expertise and hard work and expect a reward for that. Perhaps a good return on your investments is exactly what you are paying them to deliver – they shouldn’t demand more for doing their job the way you would expect.
The money belongs in your pocket. By incrementally taking more out, the larger your portfolio grows, it just means your money isn’t doing as much for you as it could do. Costs like this act as a drag on your portfolio returns.
Another issue related to percentage fee costs rising as your investments grow is that there is stark inequality in what different clients pay for more or less the same level of service.
Someone investing £500,000 might end up paying £5,000 a year in investment fees (there are other considerable costs to consider as well), while another client investing £1 million pays £10,000. Is the second client getting double the service from their wealth manager? Typically, not by any means.
This actually serves as a disincentive against investing more, and a fairer system is to consider flat fees. If the investor with £1 million consumes more services and more time, or has more complex affairs, then a flat-fee-for-service makes a fee differential obvious and fair.
When you hire a wealth manager, you want their sole focus to be doing the best possible with your assets – not thinking about how they can increase their own fees. With percentage fees, there is an inevitable conflict.
A wealth manager on a percentage fee basis is going to be inclined to encourage you to invest more, as it means a bigger slice for them. At the same time, they may be tempted to discourage you from reducing the assets held in your portfolio, for example, if you want to invest in your business or buy a property.
With a percentage fee, you will be left wondering whose interests your percentage-based financial adviser is really looking after when they give you advice. With a flat fee structure, all such potential conflicts are removed.
Percentage fee structures create a problem known as contingent charging. Put simply, a wealth manager who charges percentage fees earns money if they sell investment products or increase the amount of money they invest for clients.
There’s another conflict of interest here – is the financial adviser recommending that you invest because it’s the best thing to do with your money, or because they have one eye on their earnings?
Truly objective financial planning advice should weigh up all possibilities for what you can do with your wealth, such as clearing debts or giving money to your family or a favourite charity.
A financial adviser working on a percentage fee basis could be biased against these options in favour of putting your money in your investment portfolio. By hiring someone on a flat fee basis, you are much more likely to get an objective take on all available options.
Ready to find out just how much a flat fee financial planner could save you? Get in touch with us today and let us start making your wealth work harder for you.
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