|Not my newest client or me!|
Let's think about what the accountant said. What does it mean that your investment manager is making money? Is he really doing such a great job that he should be paid more than average, say? Suppose your $1.0 million dollar portfolio gains $100,000 higher next year. Would it be OK if your investment manager took a fee of $20,000, i.e. 2%? If you believe so, a lot of investment managers would like to talk to you. The fact is that the $100,000 represents a 10% return, and the market may have been up considerably more, 14% say. You've rewarded the manager approximately twice the average rate for significant underperformance.
But this, of course, is looking at the super naive situation. If the accountant was pressed, he would probably say this is not what he meant.
So what about those who have a good track record - those who can demonstrate that, over the past 10 years, say, they have outperformed the market after all fees and costs? Would we be willing to pay them more than the going rate? This is trickier and, in my mind, a good example of the teaching goal du jour of "critical thinking." After all, the evidence suggests that probably 10 % - 15% of investment managers out there have outperformed the market over several years. This would be expected. To see why, read my post on "Flipping Pennies."
So, to reframe the question, suppose an investment manager demonstrates that he outperformed the market by 4%/year over the past 10 years. Should we follow the accountant's advice and be willing to pay the manager 2%/year, say? The evidence suggests not. The evidence from many studies over numerous time periods clearly shows there is no consistency in superior performance. Take the 20 out of 100 managers who outperformed the past 10 years, and you'll find that only 4 of those will outperform over the next 10 years. Maybe...just maybe...the two that outperform over the entire 20 years are the superior managers, but there is no way to identify him or her ahead of time.
There is a plethora of managers who have performed well over time and who ended up flat on their faces. But most departed financially secure to make a serious understatement. Part of the reason is that people do not think critically but accept the view of the accountant when it comes to investing. Sadly, it is costing people their retirement and continually lining the pockets of Wall Street.