{"id":16511,"date":"2021-06-30T15:03:06","date_gmt":"2021-06-30T09:33:06","guid":{"rendered":"https:\/\/www.moneyworks4me.com\/investmentshastra\/?p=16511"},"modified":"2021-07-01T11:29:54","modified_gmt":"2021-07-01T05:59:54","slug":"is-variable-fee-preferable-over-fixed-fee","status":"publish","type":"post","link":"https:\/\/www.moneyworks4me.com\/investmentshastra\/is-variable-fee-preferable-over-fixed-fee\/","title":{"rendered":"Is variable fee preferable over fixed fee?"},"content":{"rendered":"

Why investors go for a variable fee?<\/h2>\n

As humans, we always seek value for money. We feel that no price is too high if there is enough value for me. However, many times value derived has a large intangible component that is hard to quantify or is derived after some time whereas prices are always tangible and usually immediately paid.<\/p>\n

Therefore when someone offers investment advisory and portfolio management services with variable fees i.e. completely or partly based on the performance delivered\u00a0 We understand why investors often get carried away in favor of variable fee structure over fixed fee structure.<\/p>\n

A fixed fee is something an advisor or fund manager charges every year irrespective of the fund\u2019s return. In good years is acceptable but it pinches an investor in a bad year or two.<\/p>\n

However, with variable fees, they find themselves willing to part away with fees, usually higher fees because they pay it only when they earn a return. However, we find this is very psychological\u00a0 (not rational) \u00a0as arithmetic doesn\u2019t add up. The typical fully variable fees range from a 10% share of profit above the 8% hurdle rate to 30% with a 15% hurdle rate. Let\u2019s work with 20% profit sharing with a 10% hurdle rate, a commonly used variable fee structure.<\/p>\n

\"fee<\/a><\/p>\n

We assumed our own past performance to find out the difference in returns from Fixed Fee and the Variable Fee Model. If you invested Rs. 10 Lac, you would end up with Rs. 29.2 Lacs in variable fee model (192% returns) versus Rs. 30.7 Lacs in fixed fee model (207% returns) after 7 years, variable fee cost you ~15% lower absolute return.<\/p>\n

We evaluated other investment options for an average investor. Here are the results. In every category, i.e. Flexi-cap, Mid-cap, Nifty 50 the answer is the same. In all the following options, fixed Fee wins hands down.<\/p>\n

\"evaluation<\/a><\/p>\n

If you had invested Rs. 10 Lac in DSP Mid Cap in 2014, it would have turned into Rs. 31.5 Lac on the variable-fee model (215% return) and Rs. 34.4 Lac in fixed fee model(244% return). Variable fees cost you an almost 30% lower return in absolute terms.<\/p>\n

\"live<\/a><\/p>\n

Why variable fee model would cost you more?<\/h2>\n

Equity markets are positive in 3 out of 4 years. So irrespective<\/strong> of a fund manager your portfolio return will be positive and most likely in excess of 10% on average as India\u2019s growth rate is 12% p.a.<\/p>\n

\"bse<\/a><\/p>\n

\u201cIf you’ve invested $1,000 with Buffett in 1965, it would now be worth $4.3 million. However, if Berkshire had been a hedge fund charging 2% & 20%, out of that $4.3 million; only $300K would have accrued to you, with a stunning $4 million charged by Buffett.\u201d -Terry Smith, Fundsmith UK<\/em><\/p>\n

\"Are<\/a><\/p>\n

Other risks in Variable Fee:<\/h3>\n