Investment advice: understanding the various fees
The main topic of discussion with your investment adviser is generally the opportunities for returns. Meanwhile, many of us forget to properly consider the impact of fees, which can have a very significant effect on the returns of an investment project over the long term. To help you get to grips with this issue, myLIFE takes a look at the breakdown of the costs associated with the support offered by your adviser.
First of all, let’s be clear that we are not talking about revealing the salary of your adviser, but rather about helping you to understand the fee structure associated with an advisory management agreement. It is not the role of myLIFE to “poke their noses” in other peoples’ business, but it is quite natural – and certainly not taboo – to investigate the costs of a particular service. After all, building a relationship based on trust means being able to talk openly about remuneration. You must be in a position to correctly assess all of the costs that can reduce your performance in order to take an informed decision on how to achieve the best results possible.
All work deserves payment
Your adviser is a financial professional who analyses a variety of financial instruments and the best allocation for your portfolios. Their role is to help you understand the economic and financial environment, share scenarios for potential market developments, and recommend financial instruments for purchase or sale in line with your personal situation, investment objectives and risk appetite. In simple terms, an investment adviser is a fitness coach who should be able to grasp the risks and opportunities associated with your investments within the context of the financial environment. And as with a fitness coach, this type of service is not purely the reserve of top tier athletes. There are also options for beginners and enthusiasts who are always looking to learn more and, of course, for experts looking for a different perspective
Remuneration for investment advisory services is based on the principle of commissions.
Investment advice isn’t something that can be made up on the fly and it is advisable to steer clear of the growing ranks of self-proclaimed gurus on the internet. This type of task requires a sound level of expertise and experience together with the appropriate information and research tools to carry it out. And for such services to be sustainable, they obviously have to be paid for. Remuneration for investment advisory services is based on the principle of commissions.
1. Management fee
The management fee is based on the value of your financial assets covered by an investment advisory management mandate. This fee is based on a fixed percentage of the level of assets covered and is generally calculated on a sliding scale. This is a simple approach with no surprises and is therefore the most widely used. However, there is one major disadvantage: remuneration is not tied to the quantity or quality of advice provided. The service therefore costs you the same amount, even in an extreme case where you have not been offered any advice at all.
2. Fee per transaction
With this system, you are charged a fee for each purchase, sale, switch, redemption or subscription transaction. This is generally a percentage of the transaction amount, sometimes associated with a minimum flat-rate fee.
Vigilance is called for here, as it is not as straightforward in practice as in theory. Not because your bank is trying to muddy the waters, but simply because the percentage fee will often depend on the type of financial instrument (equity, bond, a fund, foreign exchange transaction, etc.), but also on the specific characteristics of each financial instrument. This is particularly the case for bonds with a short maturity date which often have preferential rates to avoid penalising rotation. The fee structure may be transparent, but its calculation can quickly become complicated.
If a fee per transaction is applied, excess activity may have a substantial impact on a portfolio’s performance.
Under this model, the main advantage is that you only pay for work that is actually carried out. On the other hand, one potential pitfall is the temptation for an advisor to suggest more transactions than necessary. If a fee per transaction is applied, excess activity may have a substantial impact on a portfolio’s performance.
Some financial intermediaries offer just one of the options presented above, others a combination of the two. Some offer a third option.
3. Performance fee
This fee is applied to the performance of your portfolio and is calculated as a percentage of this performance. Sometimes it is only applied above a certain threshold that is fixed in advance. This is referred to as a performance fee.
The advantage of this method is obvious: you pay on the basis of the performance achieved – the price billed depends on the profits made. It is often used in discretionary management mandates and is less frequent in advisory management. This is quite logical as with an advisory mandate, you decide whether to carry out the transactions suggested by your adviser. You can also execute transactions via your banker that they have not recommended. This makes it difficult to clearly assess who is really responsible for the performance achieved.
Based on our research, this type of fee is never offered as the sole basis of remuneration. When applied, it is always in conjunction with one or both of the two previous methods.
Alongside the fees, there may also be other costs to consider.
As explained, remuneration for investment advisory services is based on the principle of commissions. However, there are other costs to be taken into account. Strictly speaking, these do not relate to advisory services but represent the traditional fees that the bank can invoice to you (custody fees, brokerage, etc.). You may be exempt from these types of fees with some all-in packages.
You should also bear in mind that specific fees apply to insurance policies. Lastly, watch out for underlying fees on financial instruments. Investing in an open-ended investment company (SICAV) offers diversification, but management fees in particular will reduce the profitability of your investment.
A fair price, a win-win situation
The main point to take from all of this, is that it is key to get information on all of the fees that will be applied under an advisory management agreement, including any associates fees. If you find these fees excessive, you can always discuss this with your financial intermediary. Of course, we can’t guarantee that negotiations will be successful, but you certainly will not lose anything by trying.
There is not a golden rule for working out exactly what represents a win-win fee structure. You must decide for yourself on the value added, quality and relevance of a service to assess its fair price. Considering fees shouldn’t stop you from investing but it is key to take your time and consider all the proposed options carefully.
And there is one last thing to bear in mind. If you think you’ve found the miracle product online with no fees at all, remember that most of the time “if you’re getting something for free, you’re the product”. Consider yourself warned!