Percentage-based fees - The New Pariah

I'm a percentage-based fee IFA!  There, I've said it!

For many years I have been a strong advocate of fee-based financial advice.  Thankfully, that argument has now been settled in favour of fees – explicit and agreed with the client.  Excellent.  However, now it seems the debate has moved on, focusing on when fees should be payable, at what level and upon what calculation.  

What I find interesting is how many people seem to think their model is the only model which can work and indeed how many people seem to know how best to run my business – with the most recent bone of contention being percentage-based ongoing fees.

The general tone of the argument seems to be that percentage-based fees are not fair to the client as they don’t reflect how much time is spent looking after that particular client’s investments, large portfolios cross-subsidise smaller ones and clients apparently don’t understand how to work out percentages (slightly condescending perhaps?).  

Then there is the business argument that firms shouldn’t risk having their income linked to the stock market and it can’t possibly be profitable to look after a client with only £10,000 on an annual charge of only 0.5% - expressed in cash terms that’s £50 per year!

So I want to buck the trend and speak up for those firms who, like us, charge clients a percentage-based ongoing fee.  There are many ways to calculate fees with pros and cons to them all, and perhaps it’s time to rebalance this debate.  

I would clarify that we are talking about explicit ongoing fees agreed with the client, whether paid direct or through the product.  I think it should be taken as read that any firm receiving trail commission, even if rebranded as an Ongoing Adviser Charge, has a duty, legal or moral, to actually do something for that payment.  Firms who receive trail on policies where they haven’t seen or heard from the client in years are taking money out of a person’s investment for doing nothing.  That can’t be right and the sooner that is stopped the better.

So, what’s wrong with percentage-based fees?  Let’s start with the time-spent argument and the assertion that a £100,000 investment takes the same time to review as a £500,000 portfolio.  If all you’ve done is put both investments into a multi-managed fund, a model portfolio or a DFM solution, then there’s not much for the IFA to do on the review.  In that case it’s hard to justify differing fees or indeed any fee other than a nominal admin charge. 

But that then comes down to what we do as advisers.  My view is we are there to add value.  That means asset allocating, building portfolios and, yes, picking funds.  If you do that, then the review becomes a completely different thing – monitoring and analysing performance, assessing the economic backdrop and market conditions and considering fund switches or rebalancing if required.  With this in mind, would our two investment amounts still take the same time?  Absolutely not.  The time spent is proportional (although granted, perhaps not directly) to the investment value, so why should the fee charged be any different?

While we’re looking at time spent, when did that become the accepted way to charge a fee?  In my experience the client doesn’t want us to spend whatever number of hours on their investments.  They want us to add value to those investments.  What do I mean by that?  Quite simply, they want their investments to perform better with our involvement than they otherwise would have.  I don’t think they really mind how much time we take to achieve that.  A percentage-based fee means that if we are successful with our ongoing service, and the investment grows, so too does our income.  Surely that’s a good thing, as it aligns our interests with our clients.

Compare that with a flat-rate or time-spent fee.  Both would be chargeable at the same level, even if we make a hash of our asset allocation and the client loses money.  There’s no consequence if the investment underperforms and no incentive for us to provide any proactive recommendations.

Let’s move onto the issue of cross-subsidy.  If I go into Tesco and buy a bottle of ketchup for £2, and nothing else, that can’t possibly be profitable for Tesco.  But they don’t stop me from going into the shop.  That’s because they benefit from economies of scale – the marginal cost to them for me to buy that bottle is miniscule because I am effectively being cross-subsidised by the large families who are spending hundreds of pounds every week. 

Our industry seems to be trying to individually cost each client, with the inevitable conclusion that those with less than a certain amount aren’t profitable and should be cut free.  If Tesco did that there would be a minimum spend for every visit.  

  

Cross-subsidy is a fact of life.  It isn’t some sinister tack-tick, it’s a perfectly normal business strategy that allows us to deal with all clients.  I keep looking after the smaller clients because I don’t know which ones will become larger client in the future.  As long as my business income as a whole leaves me with a healthy profit margin, even taking into account those small clients (and mortgages, come to think of it), then I have a business model that works, regardless of what some industry commentators might think.  

So there you go.  Not too much of a rant, I hope, but an argument in favour of a fee-charging model that is fast becoming the new pariah.