One per cent. It does not sound much does it? Every year an adviser takes 1 per cent of my money and for that small fee, manages it.
So I entrust my adviser with £100,000 and pay them £1,000 a year to invest my money and strike a balance between risk and reward. If at the end of the year my wealth has risen, the fee is a bit higher. If it falls I still pay a fee, just a slightly smaller one. But why should I pay at all if the adviser has failed in the job of making me money?
Many advisers tell me charging a percentage gives them a stake in their clients’ success. If the investment falls then so does their fee. They call it aligning their interests with those of the client.
But all it means is I pay a bit less when the adviser loses me money. Take my £100,000. The 1 per cent a year – £1,000 – pays the adviser to manage it (and to pay the staff, the rent, the FCA, the Financial Ombudsman Service, the Financial Services Compensation Scheme etc). Say at the end of the year my investment is worth only £90,000. Next year the charge is £900. I have lost £10,000 but I pay the adviser only £100 less. In no way is the adviser sharing the performance or the risk. If my money makes £10,000 then the fee rises to £1,100. The difference for me is huge – I lose £10,000, I gain £10,000. For the adviser it is the difference between a bad year and a good year. They have no real stake in my investment success because they still get paid for failure.
Let us forget about losses for a moment and assume in the long-term investments make money. Just how much does 1 per cent a year cost me? Time to wheel out the spreadsheet.
Say I have £100 a month to put into a pension. Let us assume it will grow by 5 per cent a year, the middle illustration for pensions set down by the FCA, and because this is a pension I will keep it from age 25 to age 65. Over those 40 years that 1 per cent a year costs me more than a third (36 per cent) of the growth in my fund. I pay in £48,000. It makes £104,000 in returns. Out of that £152,000 nearly £38,000 is taken in charges leaving me with £114,000. Some advisers of course charge more than 1 per cent – a small rise to 1.5 per cent means they take half the growth – more than £51,000.
Alternatively I could put it in a tracker and make, say, 3 per cent a year. Over 40 years with no advice charges I would end up with £93,000. So the advice at 1 per cent has made me 5 per cent a year rather than 3 per cent. The adviser’s investment of my money has made an extra £59,000 (£152,000-£93,000) over a tracker. But of that extra performance the adviser keeps £38,000 and I get just £21,000.
On top of advice charges there may be platform charges, fund management charges, share spreads, and a hundred others small fees. Recent research by Grant Thornton for a client reported in the FT suggests 2.56 per cent is a fairer estimate of how much drains away from an investment pot through the myriad taps that are screwed into it. As we bung £1,200 a year into the top more than £30 drips out of the bottom. At that rate, after 40 years of 5 per cent returns 70 per cent of the growth has been taken by the industry. Even at 8 per cent returns 63 per cent of the growth would be snaffled.
So here is my plan.
I pay the adviser a percentage of the growth in my wealth. So if my £100,000 earns £4,000 in a year I pay, say, 12 per cent of that which is £480. If it stays flat I pay nothing. If my invested money falls by £2,000 the adviser pays me 12 per cent of that which is £240. The fee is calculated on total wealth at the start of the year, minus total wealth at the end (taking account of client withdrawals) and after all charges except the explicit adviser fee. That is equivalent to a fixed 0.5 per cent fee but gives the adviser a real stake in improving the investment return.
Of course, in some years markets fall, in others they rise. Why should the adviser be penalised for market falls or indeed rewarded for market rises? Should the adviser only be paid or penalised for above or below FTSE All Share tracker fund performance which can be bought without advice very cheaply?
Or should the adviser only be rewarded for the gain above cash? I could earn 1 per cent a year risk-free in the average one year deposit or in National Savings.
Those comparisons just complicate things. Much better to look at absolute performance – have I got more money or less money at the year end?
This simple symmetrical model would encourage positive behaviour. The adviser would have a direct stake in the costs of any investment so would tend to choose investments with the lowest charges. If they wanted to take a risk with a more expensive investment in the belief that gave a better chance of more growth then they would have a genuine stake in gaining or losing. And they would have a direct stake in getting the best return on my money.
Advisers I trust and respect tell me such a model is impossible under FCA rules. Others say it would distort behaviour, be against clients’ interests, and lead to some advisers going bust.
Maybe. But one reason investors mistrust advisers is they get paid much the same for managing our money whether they do it well or badly. My plan would genuinely align their interests with those of the client.
It is broke. It needs fixing. If this does not work, what does?
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s Money Box programme. You can follow him on Twitter @paullewismoney