Right, so the idea there is they supposedly have an incentive to find well-performing funds to increase the amount they’ll earn, which is also in your interest. Win-win, right?
That’s what will happen with someone trust-worthy, honest and actually capable. Hopefully your chap is one such person.
But equally you could have someone that just sits back and does nothing of value, and just rakes in the money. For example:
- Client invests £1mil
- Good IFA John picks good investments that increase the value by 4% after a year, to £1,040,000. He then charges his 1% fee, making £10,400.
- Or bad IFA Sam picks an investment he didn’t bother researching. It only increases value by 1% after a year, to £1,010,000. He then charges his 1% fee, making £10,100. (Notice client now has less than he started with, but Sam just doesn’t need to care.)
John’s reward for his excellent performance and hundreds of hours of hard work is an extra £300 compared to Sam, who basically did nothing and laughed his was to the bank.
Basically, for an IFA on a % fee, they don’t actually have much incentive to do well. If they really want to make extra money, it’s far more lucrative to become unscrupulous and take an additional % cut/fee/kickback for investing in certain products. That way they can get 1% from the client, and 1% from the fund, and make an extra £10,000 instead of a meagre £300.