Know Your Competition…

It is important to keep in mind you cannot blame Wall Street for their actions. They are merely fighting for survival, doing what they were taught to do.

Does it make it right? Of course not.

But it’s like blaming the shark for eating the seal. Animals have been hardwired a certain way over centuries. It is difficult to reverse that instinct in any person’s finite lifetime. It happens over generations and centuries.

It’s not the individuals, it’s the system and the incentives that need to change. (My guess is this will never happen. Too many people are making too much money to let it go now.)

Most of Wall Street gets paid on transactions, not how effectively that transaction ultimately does over the long run. Underwriting fees, Investment Banking fees, and commissions are usually paid up front, and collected from each trade or transaction, regardless of whether the security goes up or down. Now, you can begin to see why Wall Street wants you to keep transacting more and more (it’s how they get paid).

Outside of commission fees to brokers, mutual fund managers are paid ‘management fees’ to cover day to day expense and salaries, regardless of how the actual fund is doing.

Hedge Funds typically charge a 2/20 fee of assets under management. This means a 2% management fee and 20% of profits (sometimes above a hurdle rate). Through my conversations with some hedge fund managers, and having been in the industry for a number of years, the fund usually pays all of its bills, salaries, and bonuses from the 2% management fee. The 20% performance fee is just a “cherry on top.”

Essentially, there is no real incentive for them to perform. All they need to do is make sure they keep your money and perform relatively in-line with the major market indices.

It seems registered investment advisors are popping up everywhere nowadays and essentially act as a “fund-of-fund” or mutual fund. They may tout themselves as having lower fees than their competition, but they are still charging management fees of at least .5-1% and then recommend an appropriate asset allocation strategy with additional fees.

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