(A little background – Bason Asset Management operates on a flat retainer fee schedule and not an asset-based percentage as is typical in this industry. You can read more about this fee structure here.)
Since I have been asked this on more than one occasion, I felt it appropriate to address here.
“If you aren’t compensated as a percentage of the portfolio, what is your incentive to grow my portfolio?”
First, let’s examine the underlying assumption behind this question: It is assumed that it is possible for an advisor or portfolio manager to directly control the behavior of a portfolio. For numerous reasons laid out elsewhere on this blog and on our website, this assumption is false.
While an advisor can carefully construct a diversified portfolio to fall in an appropriate place on a spectrum of risk and return, s/he certainly cannot:
- Know if the market is going up or down in the next week/month/quarter/year
- Know the impact of the next election/Fed notes release/quarterly earnings cycle
- Know if a stock is going up or down in the next week/month/quarter/year
- Know if interest rates are going up or down in the next week/month/quarter/year
- Identify which asset class will perform best in the next week/month/quarter/year
- Identify which fund manager will perform best in the next week/month/quarter/year
Since all of the above topics involved predicting the future, let’s agree they they cannot be done with any accuracy or consistency. So giving your investment advisor an “incentive” to do these things is as effective as offering a dog treats to sprout wings and fly away. Dangle as many treats as you like, but the dog will be no more effective when it comes to flight.
Here’s what the asset-based fee truly incentivizes the advisor to do: manage more money. Yours, ideally, since s/he knows the amount of additional work done for those additional assets under management is negligible, and the growing fee represents mostly profit. We even have a term for this in the industry: “Share of wallet.”
The other, more complicated incentive, is for the advisor to take more risk in client portfolios, recognizing that:
- This is necessary to keep up with benchmark returns due to his/her additional costs
- Higher compounded long-term returns translate into higher fees
So, when presented with the idea that an asset-based fee provides your advisor with an incentive to grow your portfolio, consider first whether this is something even under the control of your advisor. Remember that markets, not advisors, not stockbrokers, not fund managers deliver returns.