Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.
Why Evaluate Investment Management?
The finances of a company are a lot like the weather: some days you have plenty of sunshine, when the orders seem to never stop and the customers are always happy; on other days, however, your company can't seem to make enough to justify its current expenditures. All too often, it is during those downturns that serious expenses can emerge for an organization. Sure, a company may just be able to take on more debt in order to purchase that new factory or replace an aging machine, but often there is a better solution. It could very well be an opportunity to invest in a new market or region. In any event, the ability to have a robust body of investments is invaluable.
Of course, the same could be said for an individual. Sure, most of us won't be buying a factory any time soon. However, the ability to save for the future and invest in new property or higher education is a valuable skill. No matter if you are a business or an individual, that means you'll have to have investment management, or those who look after your investments. In this lesson, we'll see why it is so important to evaluate them.
By far the most important aspect of an investment manager that you should evaluate is their ability to make sure that your investments perform well. In short, investments should return a profit. However, it's not as simple as getting a profit eventually, but making a profit and guaranteeing that it is available when you need it. Even at 1% interest, a dollar will eventually turn into a million bucks, but most of us won't be around to see it.
It is crucial that performance is weighted against inflation. If inflation is 5% but your return is only 4%, then you are losing 1% every year. A good investment manager will avoid this scenario.
Fees for Investment Management
Of course, there is no such thing as a free lunch. Investment managers do cost money. There are a number of different fee structures that investment managers use to make money from their clients.
Asset-based fees are when the investment manager takes a percentage, normally around 1-2%, of your assets under management every year. For example, if you allow them to manage $100,000, they will take 1-2% of that total every year, so between $1,000 and $2,000. In theory, this should keep them focused on making you money. After all, the more money they help you make, the more money they make in the future. However, in practice, it can mean that investment professionals want you to keep more money under their management so they can get a larger fee every year rather than put it someplace where it would do you more good.
Fee-based fees occur when an investment professional charges an up-front fee every year. Often this starts at around $2,000 a year and can go up higher. The biggest advantage of this system is that you know exactly what you'll be paying in a given year. However, there is also the chance that an investment manager may not focus as much on your investments. After all, he or she has already made a profit off of you.
Commission-based fees are another very common way for investment managers to make money off their clients. These exist when a manager earns a percentage of each investment that you buy, much like a commission for a car salesman. So what does this mean for you? Simply put, you won't directly pay your investment manager. Instead, when you buy an investment, he/she gets paid by the investment company for selling you that investment. As you might expect, that means that the investment manager is going to try to push those investments that pay him/her the most. Sometimes these could be high-performing funds, but other times they aren't a wise investment.
So Why Evaluate?
All of this brings us to our big question: why evaluate investment management? Again, the answer is two-fold, as you saw in the previous explanations. First of all, if an investment manager is simply underperforming, that's an inefficiency. You wouldn't keep around a transportation company that is always late, so why fool with an investment management firm that simply can't keep up? Also, you deserve to be valued. If all you're getting is a phone call and an annual report while your investment manager makes money off of your assets, fees, or commissions, then he or she is not doing you any real service.
Okay, let's review. It's important to evaluate investment management, or the people who look after your investments for two major reasons. The first of these is performance. Not only should your investments make a profit, but they should also beat inflation with that profit. Also, you should make sure that your fee structure is as efficient as possible. Investment terms offer a number of different fee structures. Asset-based fees are when the investment manager takes a percentage, normally around 1-2%, of your assets under management every year. Fee-based fees occur when an investment professional charges an up-front fee every year. Finally, commission-based fees exist when a manager earns a percentage of each investment that you buy.
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