Performance fee baloney.

The Banker’s Umbrella began in January of 2013, and as it turns out it seems to have become rather popular. The Banker’s Umbrella is loved by many and hated by a few. Not bad for one (former) banker and a laptop.

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Performance fee baloney.

You know that look teenage kids give their parents at least twice a day? You know the one I mean. The “Oh no mom, not again! I’ve heard it a million times” look. Yes that one. As a private banker I’ve been in countless situations when I’ve had to suppress that look when meeting a certain type of potential clients

So what’s that certain type of potential client, you ask?

Well, it’s when a prospective client asks you if you can offer them an investment advice that is based on a performance only fee. This question is always and without fail delivered with a smug smile, the type that says “Aha! Aren’t I smart? I bet no one’s been as smart as me to suggest this idea to you.”

Well the truth is that several people have suggested it (hence the teenager look of disproval). To be perfectly blunt it’s a bit of a silly suggestion, because performance based fees can be harmful to the investor.

People who believe the answer to better investment advisory returns is performance fees have no idea of the basic ethos of investing, which is the relationship between risk and reward. The greater the risk, the greater the possible reward, but also the greater the probability of defeat.

It is a fallacy to believe that performance fees align the investor’s and the adviser’s interests. If you stop to consider this point for a moment, you will realize that this is basic human psychology. If you give someone a bundle of your money and tell them you’re going to pay them a share based on how much profit they bring back, then that person will try to turn around as quick a buck as possible, and should the first deals head south, they’ll keep doubling up and doubling up until they make a profit or go bust… with your money.

When an adviser’s salary is dependent on gaining the maximum amount of profit, in as short an amount of time as possible, with your money, then they will, 100% of the time, to use a term from poker, go all-in. In fact performance fees are an all-in all the time way of playing poker with your money.

So what’s the answer?

Most importantly never, never, never believe a salesperson’s spiel that performance fees are good for you, the investor. In fact there is only one fee structure for advice that is one that (unfortunately) remains relatively rare, that is a fee-only structure.

A fee-only structure is fair for both sides: The investor and the adviser. The investor gets to carry the risk with his capital, as he should, and the adviser’s recommendations are not skewed by a hard to resist, short-term greed incentive.