Performance-based fees are not a sensible remuneration model for financial planners. No form of remuneration that is linked to investment outcomes is truly satisfactory. A planner’s income need not rise or fall depending on investment markets – which are driven by factors completely outside the planners’ control and influence.
This is an argument against performance-based fees as an
appropriate remuneration model for financial planners. But there are
strong arguments in favour of the model. Please leave your comments and
views at the bottom of the story.
A financial planner whose basic value proposition continues to focus on investment is playing a very dangerous game. If a client is promised a particular investment outcome, and then, for no fault of the planner’s, that promise cannot be honoured, then there’s only one certain result: A seriously annoyed client.
It’s been reported today that according to the research group Investment Trends, roughly one-fifth of financial planning clients think performance-based fees are the best way to pay for a planner’s services. But planners need to think very carefully before acceding to this demand.And some of the same arguments apply to asset-based percentage fees.
A remuneration model that allows a third party to dictate to a planner what they can charge for their services is fundamentally, fatally flawed.
Being a professional involves, among other things, setting a price for a service based on the quality and the competence of the service provided. If a planner has a certain set of qualifications, a certain number of years’ experience and a certain level of expertise, it’s these things that should determine the cost of a service provided. Not whether the S&P/ASX All Ordinaries Index happens to be up or down this year; and not the amount of assets a client walks through the door with.
It’s understandable why some planners want to be perceived as investment gurus, and to make promises to clients along the lines of being able to pick the top-performing funds or the best-performing stocks. When they get it right, it makes them look good at barbecues and dinner parties. But then they get it wrong, they look like complete knuckleheads – and it causes unnecessary angst for clients.
If a value proposition is all about investing then that’s fine, but there needs to be some truth-in-labelling: that’s investment advice, not financial planning.
But there’s another, more prosaic reason for wanting to avoid performance and asset-based fees.
Let’s say, for argument’s sake, that the income of a planning firm comes from an asset-based percentage fee, and let’s also assume that the value of a planner’s clients’ assets pretty much reflects the sharemarket.
According to data from Vanguard Investments, in 2004-05 the firm’s income would have risen by about 25 per cent, then by about 24 per cent the following year, and by about 30 per cent the year after. So far so good. But then in 2007-07 the income fell by 12 per cent. And then in 2008-09 it fell by 22 per cent. In 2009-10 it clawed back some lost ground, rising by about 13 per cent.
(Business analysts talk about a “double-whammy” for “investment-based” practices when investment markets tank: income falls; and clients who were made an investment promise become annoyed and can walk, taking all of their assets with them, thus exacerbating the drop in income.)
What will be this practice’s income this financial year? What will it be for each of the next five years? How do you plan and budget, when you have no idea, and no control over, what a your income will be?
On the other hand, if income comes from finding, retaining and servicing clients, and charging a fee for those services, which is likely to produce the more consistent and reliable income stream? Which one is likely to result in the most satisfied clients?
And which one might a potential buyer value more highly?
If, as Investment Trends is also reported as finding, the level of income is roughly the same, regardless of the fee structure, then it’s just good business sense to want to remove the volatility and uncertainty.
Agree? Disagree? Have something else entirely to add? Click below to leave your comment.
