It is vital that you understand wealth management fees – how they are charged and the different components which may apply.
Charges vary from wealth manager to wealth manager and the headline fee number may not tell you the whole story; you have to understand the total fees you will pay.
The Retail Distribution Review is a wholesale reform programme for the UK financial services industry. It brought in many changes intended to ensure customers are treated fairly and to improve competition within the sector. One of the headline changes was to make financial services firms, including wealth managers, more transparent on fees. It is now far easier for individuals to know exactly how much they are being charged for services than it once was.
How it works
It is essential to understand how much you will be paying for your wealth management service package, and how it will be affected by market rises increasing the value of your investments, for instance.
Management fees
Your private bank or investment manager will probably charge an annual headline management fee for running your investment portfolio. This is typically around 1.0-1.5% per annum, as a proportion of the total assets under management. These are also known as “ad valorem” fees.
Banking fees
If you are using a private bank, you will usually be charged custody fees on deposits in the range of around 0.2% a year.
Transaction fees
Transaction fees may or may not be included in management fees, depending on the nature of the relationship you have with a wealth manager.
It is always prudent for investors – particularly self-directed ones – to consider the impact of transaction fees. Changing your investment holdings too often, known as “churning”, is a well-known drag on profits; it is all too easy to see returns eaten away by fees. You should also bear in mind that wealth managers are often able to use their bargaining power to obtain fund discounts which are simply not open to the do-it-yourself investor.
Product fees
Investment products like funds, hedge funds, private equity and structured products can carry an upfront initial (entry) fee, annual management fees and an exit fee. Wealth managers are obliged to tell you what the total fees are per annum and you should ensure you have a clear understanding of what you will be asked to pay.
Total expense ratios
Total Expense Ratios (TERs) allow investors to see at a glance the total costs of holding an investment. These are available from fund managers and wealth managers and are a good guide to total annual costs (in a similar way to an APR on loans).
An example of the effect of fees on portfolio value over time is as follows: Assuming constant returns 10% per annum for two fee structures: a TER of 1% versus a TER of 1.5%. All else being equal, £1,000,000 invested over 25 years shows a return difference of almost £1,000,000 (or the entire original investment). Even the seemingly small 0.5% can make a huge difference to your overall wealth over time.
Performance fees
Performance fees are based on the returns a wealth manager delivers from running your investment portfolio, calculated as a percentage of the overall performance. Your wealth manager may or may not charge a performance fee.
The advantage of choosing a wealth manager which charges performance fees is that you only have to pay them once a positive return over a certain threshold has been achieved. However, it can be hard to distinguish genuine outperformance from general market rises. Detractors might also argue that the main risk of a performance fee model is that the wealth manager takes on investments which are too risky, although investment suitability and risk management are top priority at all reputable wealth managers.
Summary
The issue of fees in wealth management is more complex than it initially appears, since they may be comprised of so many different parts. You should also bear in mind that, although fees can make a big difference to overall returns, cheaper isn’t always better. Competition on fees has increased with the greater transparency brought in under the RDR and where there is a significant difference in fees it is probably likely due to a significant difference in the two firm’s offerings. As with most things in life, you may feel that a higher-quality or more personal service is worth paying a premium for.
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