I didn’t do Latin at school (I was in the German stream), so I had to look up “ad valorem”. My online dictionary reveals it is the Latin for “rip-off”.
Estate agents love ad valorem, although they are not usually posh enough to call it that. Almost all charge a percentage of the selling price of the property. The average is 1.4 per cent, though it can be as much as 3 per cent.
Do they do four times more work to sell a £1m house as a £250,000 flat? No. Does a London agent do more than three times the work of one in Wales? No. Do London agents work 60 per cent harder today than they did five years ago? No, no, no.
They get away with it because such a large amount of money is passing through the seller’s hands that a thin sliver of it is hardly noticed. It is their tax on selling, like stamp duty is a tax on buying.
I guess half of the advisers reading this are nodding in agreement: “Hmm, yes, ad valorem is a rip-off. Never thought of it like that.” But the other half will be thinking: “Hang on a minute, isn’t that how I charge my clients?”
Indeed, the FCA found around half of regulated advisers impose this tax on the wealth of their clients. The average maximum charge is 3 per cent upfront and then 1 per cent a year.
Hitting the bottom line
A 1 per cent charge does not sound like very much but that drip, drip, drip out of the bottom of the pot is destroying clients’ wealth. Compound interest may be the eighth wonder of the world to create wealth but a percentage charge uses the same maths to destroy it.
IFA Capital Asset Management chief executive Alan Smith has produced figures that show an investor with £1m held for 30 years with a 1 per cent a year fee could be £1m worse off at the end than someone who paid an annual flat fee for the advice.
His slightly heroic assumptions are an investment return of 7.6 per cent and inflation of 2 per cent. He assumes both fees start at £10,000. The flat fee rises with inflation, while the 1 per cent fee automatically rises with the client’s wealth.
At the end of 30 years the investor with the IFA charging a flat fee will have assets of £7.7m, while the investor paying 1 per cent of their wealth will have £6.7m. Most of that £1m difference has gone to the adviser. No wonder many prefer that model.
If the assumptions are changed, the outcome is less dramatic. But the principle is the same. Imposing a tax on the wealth of your clients – even a small one – compounds over the years to a much more substantial drain on their money than charging a fee for the work you do.
Of course, at some point in your client documentation you have to say what your charge is and give this year’s fee in pounds. But full disclosure would reveal it might amount to them having £1m less in their investment fund over 30 years.
“A 1 per cent charge does not sound like very much but that drip, drip, drip out of the bottom of the pot is destroying clients’ wealth.”
One reason given for using a percentage charge is that it helps those with low assets. Someone with £25,000 can afford 1 per cent of that (£250) but would be reluctant to pay £1,000, which would be 4 per cent of their total wealth.
Advisers argue there is a cross-subsidy that helps the less well-off afford advice. If so, then an adviser should be explaining that policy clearly to their £1m clients. If it does not really cost £10,000 a year to manage their wealth, they must be told they are paying over the odds so that a poorer client’s fee can be subsidised.
It is also a myth that a percentage fee somehow aligns the adviser’s interests with their clients’. If a client’s wealth falls from £1m to £900,000, they lose £100,000 – but the fee is just £1,000 less at £9,000. In fact, it can misalign interests. Buying a property to let out or paying off debt may be the best advice. But the adviser’s interest is for the client to maintain the invested assets on which the percentage fee is charged.
In the bad old days, there was an upfront commission payment and trail commission for the life of the product. That is replicated in a percentage signing-on fee and a percentage annual charge. In reality, both are a client’s wealth dripping out of the bottom of their pot while dividends and capital growth fill it from the top. Even if dividends dry up and capital growth goes into reverse, as they will from time to time, the tap at the bottom still leaks client wealth out to the adviser at much the same rate.
France is one of the few European Union countries to impose a wealth tax. It begins at 0.5 per cent on wealth over €800,000, rising to 1.5 per cent tax on assets above €10m. French taxpayers get efficient trains, excellent healthcare and nuclear weapons. What does an adviser offer for the tax they charge that could not be sold for a fixed fee?
These and other considerations led Alan Smith to move Capital Asset Management’s charges away from a tax on his clients’ wealth to a fee for the job done. I have met several advisers who have made, or want to make, the same move. I hope this movement spreads.
PS: Ad valorem does not really mean rip-off. It means by value. One thing I learned from my German lessons was: Halten sie immer ein wörterbuch zur hand.
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programme. You can follow him on Twitter @paullewismoney