A performance fee is simply a payment made to a fund manager for generating positive returns. A performance fee is charged on mostly all investment funds in the market today. Whist many investors don’t pay much attention to the performance fee when they invest in a fund, these performance fee can have a huge detrimental impact on your returns over your investing lifetime.
Fund mangers say they align interest when they charge performance fees.
With this is mind, do you think when a fund makes positive returns, it is reasonable for you to get 80% of the winnings or upside whilst letting the fund manager keep 20%. And when the fund loses money, you lose 100% and they lose nothing.
Any rational person would know that this is not a fair deal. By paying performance fees, you take all the risk but only get 80% of the reward. Is this logical to you?
One of the worst things investors say is that it is only 20% of the gains which is sounds reasonable. Well its not, as many people have not taken account of the fact that the ’20% lost’ will be compounded over time and you will lose a heck load of money.
I’m sure you have heard of Berkshire Hathaway run by Warren Buffet. If you invested $1000 with him since June 1965 when he took over Berkshire Hathaway, your money would have grown to about $7 million by the end of 2013 (much more now!). That is a very impressive return on your investment. That is nearly 20% per annum compounded.
Now Warren Buffet is co-invested with you as he owns shares in Berkshire Hathaway. Warren doesn’t really charge fees (only charges a paltry $100,000 directors fees per annum). Now lets say Warren Buffet ran Berkshire Hathaway as a hedge fund and charged 2% of assets and he also got 20% of any gains. What would your returns be now? Your $1000 would have turned into about $700,000. If Berkshire Hathaway had charged a performance fee like many funds, you would have lost $6.3 million. This is what performance fees do to your gains.
So what aligns interest?
Not all funds are highly skewed to favour the fund managersIn terms of mutual funds, the only thing that can ever align interest is if both you and the fund manager are invested in the same fund. Make sure that before you invest into any fund, do your research by checking if the fund manager has put their own money into the fund.
Here is a good calculator for anyone wanting to see the effect of fees on performance: “
You should never pay performance fees! They are the biggest hurdle to investing success!