How Money Managers Get Paid (Can Hurt You)

Investors are always walking a careful line between reward and risk. A little more risk might mean a little more reward – but too much risk can lead to a total loss of principal. Imagine being able to make money in the market without any financial risk at all? It seems like an impossible dream – but money managers have that luxury. 

Money managers profit without risking a penny of their own. While most act in your best interests, that’s not always the case. It’s critical to understand how money managers can screw you, what to watch out for, and how you can keep more of your returns.  

What Money Managers Do

Many investors find that managing their portfolios independently is a difficult task. Researching investments, making trades, and rebalancing is time-consuming. Those outside the world of finance are missing important experience and expertise that can directly impact portfolio returns. 

Money managers do this work for you. They examine investment opportunities and select an asset mix that meets your goals and your ability to tolerate risk.

Money managers have a duty to act in your best interests, so you can trust that the reputable ones are making a good faith effort to achieve the objectives you set. However, the work they do comes at a price – and the amount you pay can dramatically impact your portfolio’s long-term performance. 

How Money Managers Get Paid 

Money managers aren’t paid by the transaction generally (unless they receive a commission from buying mutual fund A-shares for example), so they don’t usually make their money by making trades.

That takes an important concern off the table – you and your money manager are on the same side, so there is no incentive for money managers to screw you with unnecessary transactions to generate commissions. 

Instead, money managers use a fee-based method of payment. They are paid based on the size of your portfolio. Ultimately, it is in your money manager’s interest to grow your portfolio as much as possible, because that means more in their pocket. 

It seems like nothing can go wrong with paying your money manager a fee based on a percentage of assets – right? If you both have the same goal – to increase the size of your portfolio – then it’s always a win/win situation. Or is it? 

How Money Managers Can Screw You, Even When Your Portfolio is Growing

A money manager’s job is to deliver returns, so if your statements show growth, you might be satisfied – but look closely. The fees you are paying your money manager could be eating away at your profits. 

Review your statement with a particular focus on fees as a percentage of assets. A figure that comes in around two percent might seem reasonable, but think through what that means for building your wealth long-term. 

A money manager who charges two percent of your assets each year for 30 years enjoys plenty of returns with no risk at all. If a performance fee is added in, the money manager has to grow your portfolio to get the extra amount. Still, that doesn’t risk any of their own money – it’s simply an additional incentive to do a good job. 

The problem is that money managers can screw you with a collection of fees that appear fair and straightforward at first glance.

Once you have added them up and assessed the true impact, you realize you may be losing most of your returns over the long term to your money manager. In other words, they are profiting more than you are, though you are the one taking on investment risk.

A Closer Look at the Impact of Fees on Your Portfolio

If your money manager is committed to transparency, your statement should itemize all of the fees charged to your account. Examples include: 

• Initial Fees
• Maintenance Charges
• Tax on Maintenance Charges 
• Commission Charges 
• Ancillary Charges
• Other Costs (e.g., Negative Interest)
• Entry/Exit Fees
• Management Fees
• Performance Fees
• Transaction Fees

Some of these fees are mutually exclusive, so you shouldn’t see charges in every category. However, chances are, you are paying a combination of these expenses from your account monthly, quarterly, or annually. 

The basic management fee might be just two percent, but the addition of other charges can take that total up. If your combined fees total – for example – five percent, it is difficult to realize meaningful returns. 

Consider this: 

Your initial investment totals $100,000, and your total expenses are five percent. That means your portfolio must generate returns of five percent just to break even.

After two years, you are down by 10 percent, so you need an 11 percent gain to get back to breakeven. It’s nearly impossible to win, because you are taking all of the risk while your money manager makes most of the gains. 

Even in a good year when your portfolio returns 10 percent, half of that goes to your money manager. That’s not sustainable if your goal is to grow your portfolio’s value over time. 

Don’t Let Money Managers Screw You

Keep more of your money – and your returns – by paying careful attention to account management fees. If your money manager charges more than the industry average, be direct and ask exactly what value they are adding to justify the extra expense.

Few can justify higher than average fees. Every once in a while a Renaissance Capital comes along with a unicorn manager like Jim Simons who cracks the code to the market, but very few investors will ever stumble upon someone so successful, let alone have the opportunity to invest with them.

You may also consider keeping some or all of your assets in passively managed products. These require less work on the part of your money manager, which means lower overall expenses for you.

It’s worth noting that unless you have a particularly talented money manager, actively managed accounts don’t generally outperform the market. In other words, the extra amount you are giving up to fees doesn’t pay for itself with higher returns. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.