The Compensation Paradox
Yesterday I met with a CPA whose client paid $65,000 in fees to his advisor last year. Let that sink in for a bit.
That is a full-time salary. This man obviously had a large portfolio (~$10 million) so on a percentage basis, that fee might seem small. After all, it is only 0.65% which is actually lower than the average advisor fee for that asset level (0.74%).
This advisor actively traded his client’s portfolio, making over 200 trades during the year. There were some big winners and big losers. Overall, the client paid more in fees than he received in returns.
That’s fine. It happens. Your portfolio won’t go up every single year. Whether or not your portfolio goes up in a given year is largely out of your (or anybody else’s) control. I’ve addressed the problems with asset-based fees many times in the past and won’t rehash those here. The question I’ve been thinking a lot about, though, has to do with the pressure an advisor puts on himself by ACCEPTING that type of fee and the detrimental impact it could have on the client’s portfolio.
If somebody was paying me $65,000 a year, I’d feel a lot of pressure to do something. The CPA I was talking to said the advisor talked about all sorts of complicated oil futures trades, where he thought emerging markets were headed and why he thought it was a good time to buy oil & gas exploration companies. He came off as sophisticated but does sophistication always equate to value? I don’t think so.
A simple rule of invisible alpha is that complex markets don’t require complex solutions. Morgan Housel wrote a great piece this week outlining Why Smart People Make Bad Decisions. When investing, most academic evidence shows us that less is often more.
I believe excessive compensation structures heavily influence the poor decisions made by many advisors and investment managers. Paying more doesn’t always mean you get more. This is a topic I’ll be exploring more next week when I dive into the differences between the Massachusetts and Nevada public pension systems. Simple vs Complex. Until then, enjoy your weekend!