Performance Fees – Make it Fair

In 1940 Congress created the Investment Act of 1940.  This Act was essentially rules created to stave off another stock market crash like the one that happened in 1929.  The Investment Act of 1940 was put in place to better regulate the investment industry. One of the provisions of the act is that it permits Investment Advisors to be compensated on a performance fee basis, but only with a “qualified client.”  A qualified client as of today September 2016 is a client that has a net worth (not including their residence) of over $2.1 million dollars and at least $1 million under management. This dollar amount gets reviewed and adjusted every five years.  The justifications that I have read regarding the basis around this act is supposedly it was written to protect the consumer from Investment Advisor’s taking unessary risks with client’s monies in order to gain fees. The rule protects the consumer that doesn’t have enough money to not be protected if that makes sense.

I’ve often wondered about this rule.  I like to view it backwards just to point out how incomplete it is.  Backwards this rule says that if you have a net worth over $2.1 million or more than $1 million under management then you know enough about investing or working with an Investment Advisor, so it is okay for that Advisor to take unecessary risks with your money.  I find this odd. Just because someone has a higher net worth doesn’t necessarily make them better or more akin to understanding investments. There are lots of “qualified clients” out there that are on the same level as non-qulaified clients when it comes to investment knowledge.  I guess they presumed that qualified clients can higher more professional people to advise them or watch their money, or maybe they think they have enough money that losing some of it won’t hurt? I really am not sure, but I can tell you that I haven’t met many people who like to loose money.

So why am I bringing all of this up?  I am discussing it, because I feel there are better ways to protect consumers and keep everyone on the same playing field.  In a way this act seems discrimenatory. There are investors out there that are very astute and that don’t meet the qualified client definition.  Why can’t they hire someone to work on a performance basis for them? It doesn’t seem right.

There are other ways that Congress could regulate these fee rules and keep everyone on the same playing field.  They have found a way to protect IRA’s and retirement accounts by regulating what can and can’t be placed in them.  They could employ these same types of rules with some added touches so a non-qualified client could higher an advisor on a performance basis.  Or they could implement qualification testing as a way of testing a client’s knowledge.

Until things change clients that aren’t qualified clients are left to work with Investment Advisors either by a percent of assets under manangement, by the hour, or by some other method than performance fees.  Knowing this there are ways you can make this work for you. Some simple suggestions would be to make sure you are paying your percentage fee at the end of the time period you are under. For instance, if you have an annual contract your fee should be calculated at the end of that period, so you are paying for the past performance just in case you have less money at the end of the time period.  If you choose to try things on your own go to classes and pay for a hour of consultation to gain better knowledge, but make sure you come to the hour prepared with specific questions, so you make the most of your paid time.

Until something is done to eliminate the discrimination and not determine someone’s investing qualifications based on net worth be smart about your choices and plan how you want to employ your help.  Statiscally and according to research eighty-five percent or less of fund managers have been able to beat their bench mark averages over time, and those that do beat the averages only do so by a little other than a very select few, so picking where you get your advice is just as important as what investments you choose.  To grow your wealth you must grow your knowledge.