The finance industry involves many talented people trying to get money out of people for nothing.
At the risk of getting expelled (again) from the Finance Industry Insider’s Club, I won’t to expose one of the most common scams in the finance industry:
Performance Fees.
This isn’t so much a property thing. It’s a money management thing. It’s what happens when you pay someone to invest in the share market for you.
And since I know a lot of people reading these emails are in the early stages of their financial journey, I thought it’s worth highlighting this scam as something to watch out for.
So you pay a fund manager to invest in the market for you. You pay them a fee to do that – normally a percentage of how much money they’re managing for you.
Sometimes – and they don’t all do this – you also have to pay them a performance fee. If they beat a certain benchmark – say the ASX200 – then they get a cut of that outperformance.
The idea – supposedly – is that this aligns your and their incentives. The more money they make for you, the more money they make for themselves.
It’s a scam.
First up, note that it’s not symmetrical. I’ve never heard of a fee structure where if they underperform the market they give you some of your management fee back.
It’s all carrot and no stick. Are we really aligning incentives then? Are we really on a ‘shared journey together’?
Second, isn’t this just what you’re paying for anyway? Aren’t you paying them to beat the market?
Because hitting a benchmark like the ASX200 is actually dead easy… and cheap. You just buy a publicly listed exchanged traded fund (ETF) – like any other share. Done.
And these days, with so many accessible ways for ordinary people to invest in the market, a money manager needs to be bringing some special sauce.
So the whole point of a money manager to get more than what you would get if you just stuck it in an ETF.
But if they do the thing that’s the whole point of what they do? Extra performance fee.
Finally, because there’s no downside for them, it incentivises risk taking. If they take a big gamble and it pays off, they make good money (though so do you.)
But if it falls over, as risky bets are prone to do, well, sucks for you.
So the way I see it, performance fees are just another way for the finance industry to fleece investors too lazy or too naive to know what’s going on.
So watch out for them on your financial journey. I’ve never seen one that was a good deal for the consumer.
DB