Trail fees: right or privilege and what do we do to justify them?

Ideally, in my opinion, trail fees should be paid directly by the client. Practically and logistically this is an administrative nightmare and so the reality is that it is easier (for everyone) to have the fee paid by the company. Much has been written about whether this form of payment is a fee or a commission. Frankly, I don’t really care. What matters is that we accept that trail fees are a privilege and not a right. They are paid by the companies from the clients’ accounts and the clients are fully in control of this transaction (although most of them are not aware of this or, in many instances, the quantum of the fee).

So what is it that we actually do to justify this (often substantial) fee?

I think that one of the reasons we don’t really talk about this fee to our clients and why there is suddenly a proliferation of “all-in” products is that there is a sense that we don’t really believe that we deserve the fee. In many instances, if asked, I think we would struggle to articulate why we are getting paid. As a result we are uncertain of the role that we play and we tend to “fiddle” too much in order to be seen to be doing something to justify the fee. As a result of this uncertainty – even in our own minds –we do a couple of things that are not in our clients best interests: we switch our clients’ funds and/or we frequently take the path of least resistance so as to keep our clients happy (or so we think). While both of these actions may give the appearance of us doing something on the clients’ portfolios, both can have devastating consequences for our clients.

Consider the effects of switching on investment returns. Both the international and local research shows that clients who switch frequently (in the hope of chasing performance or timing the markets) tend to significantly under perform the market.

In my own practice this was very clearly demonstrated by the following example. Client D invested ±R900000 in a preservation fund (via a LISP) about 5 years ago. Before the current bout of market volatility it had grown quite nicely to about R1.8 million over the period – a return of ±15% per annum – not bad at all. However, the client discovered very soon after making the investment that he could switch online. As a result he has switched every months for the past 5 years. As much as I have tried to discourage him or even excuse myself as his financial planner, he has insisted that there have been good reasons for his switching (usually short term under performance by one or more of the funds) and has also insisted that I stay on in my capacity as his (fee-earning) financial planner.

The real cost

This has long been a source of concern for me and recently I decided to look at the facts and work out what his funds would have been worth if he just left them where we had invested them 5 years ago (65% equities and the balance in bonds, cash and property with ±20% offshore exposure). I suspected that the result would be ugly – but did not expect it to be so bad. If he had left the funds alone they would have grown to ±R3.2 million. Almost 26% per annum as opposed to his ±15% per annum…a difference of ±R1.4 million! That’s the real cost of switching. I was then left with the difficult task of informing the client…

All’s well that ends well as they say and the point was well made and even more graciously taken. But the lesson for me is that more often than not, we as advisors and planners earn (and justify) our ongoing fees by doing nothing and by making sure that clients do the same. Most clients are not aware of this and this is where we have a huge role to play in educating them about the effects of not sticking to the plan. There is seldom a good reason to switch funds…we know that we can’t time the markets so why do we pretend that we can or why do we let our clients think that we can or worse still, that they can?

Having said all of the above, there are, however, a few good reasons for making changes – these include rebalancing the asset allocation (especially at times like this) or taking action when fund managers leave for greener pastures. But on the whole, it is my opinion that we should switch far less than we do and we should encourage clients to do the same. That way, we would really be earning our fees.

On the second issue of taking the path of least resistance, we all too often will do this in order to keep a client happy for fear of losing the client and/or the business. Consider the following situation: a client goes to see the doctor (because she is ill) and then when the doctor prescribes a course of antibiotics to cure the illness, the client turns around and says that they don’t think they like that anti-biotic, can they rather have a different one please?

I doubt whether any doctors would entertain such requests (unless of course there were really valid reasons). More likely there would be a stern talking to and a reminder about who is the doctor and who is the patient…my suspicion is that because doctors get paid differently to advisors, they are less afraid to speak the truth for fear of offending/losing the patient/client.

It is time that we as advisors/planners started respecting ourselves (and our clients) more and time that we started reminding them of whom the financial planner is and who is the client. “This is the product/course of action that is appropriate for you and your situation and if you don’t like it then find another financial planner!” “Now is not the time to be deviating from investment plans by bailing into cash…if you are investing you are in for the long term and it is time to ride it out, Mr Client. You are not going to get out of your funds at the bottom so that you can get back in later when the prices have increased.”

It is at times like this that we as Financial Planners really earn our keep – we need to remember that more than managing money, we manage people and the emotions that they have around money.

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