Why aren't there advisor fee structures that are more fair to the client?
Is there a financial advisor that has a fee based on the percentage of profit made from the investments that they recommend and make with a client's money? This seems like a fair way to structure client fees. For example, if a client's portfolio sees a gain of $10,000 at the end of the year, the financial advisor takes a pre-negotiated percentage of the profit. If the portfolio has no growth or a loss for that year, than there should be no fee. Right now, my advisor is the only one making money off of our investments, and I am suffering losses from fees on top of losses from investments. Why isn't there a more fair fee structure implemented by financial advisors?
It boils down to his or her role as a fiduciary. If his fee is based on a percentage of profit each year, it may lead the advisor to recommend riskier or more aggressive investments throughout the year. These investments will have the potential for larger returns (good for the advisor) but also have the potential for larger loss (bad for the client). If you make a good profit he will take a cut, but if you lose in this scenario there isn't much of a downside for the advisor.
If you are aren't seeing the profit you are happy with, it may be time to look for a new financial advisor.
That performance fee scheme is what hedge funds use. They have just one purpose – performance. They are structured as partnerships between accredited investors, not SEC registered advisors. Performance fees aren’t allowed for most individual investors because they encourage risk. It may seem to be fairer, but it isn’t really; in the broadest understanding of economics, the only way to increase returns is to increase risks in the portfolio. So, to raise performance, you must increase the percentage of risk assets. Of course, that also increases the chances that the portfolio will suffer at certain times.
Importantly, performance isn’t a good way to measure an advisor’s value anyway. http://www.investopedia.com/advisor-network/articles/investment-performance-bad-measure-advisor-value/ I’d suggest that a good advisor should be seen more as a professional consultant regarding financial matters. He or she provides insight rising from an expensive array or resources … staff, software, research, continuing education, and a smattering of psychology and sociology. Additionally, he or she has zero control over the economic environment. This is a professional relationship; it’s simply unfair to expect one party to cover all costs when times are bad.
Yes....this SEEMS fair but there is a big problem with this arrangement - actually two probelms.
First, it gives the advisor an incentive to take undue risk because they participate on the upside so risk abatement is not a problem for them - only you.
Second, if your account losses money, lets say 10% and the market losses 20%, does that mean the advisor did a bad job?
Advisors have to pay for expenses no matter what the market does and the last thing you want is to work with an advisor who isn't worried about risk and has a big incentive to take big risks with your money.
Your question implies that a good advisor can select and time the purchase and sale of investments in such a way to always result in rising account values. Let me be the first to tell you that no advisor can do this. No one can predict the future price of any security or market. Investment advice is one area of advice within a complete financial plan; other areas include but are not limited to Cash and Liability management, Insurance evaluations, Estate Planning, and Income Tax Strategies. Within the area of investment advice, the most valuable advice I give is in a bear market, when clients desperately want to sell low.
The model you are describing would result in the financial advisor going out of business in a bear market, precisely when the advice is most needed.
For more insight into the inability to choose investment "winners", research the Efficient Market Hypothesis.
I believe that the value that financial advisors should provide to their clients should beyond investment recommendations and financial performance. If this is all you get from your relationship with your financial advisor then you are working with the wrong person. Fiduciary financial advisors could offer a variety of services including but not limited to financial guidance, financial planning, college planning, tax planning, estate planning, exit planning, debt reduction, real estate management and so on.
Hedge funds are the only financial entities I know that are compensated based on performance and they haven't done very well lately. Many of them have underperformed the market for quite some time. If financial advisors start getting compensated based on performance they will turn into stock pickers which should not be their core competency.