When performance-based fees are allowed, what must be disclosed to the client?

When performance-based fees are allowed, it is essential for the advisor to disclose to the client that this arrangement may cause the advisor to recommend strategies that encourage greater than normal risk. Performance-based fees provide an incentive for financial advisors to achieve higher returns, which can lead to taking on more investment risk in pursuit of those performance benchmarks.

By disclosing the potential for greater risk, the advisor helps the client understand that while there may be an opportunity for higher returns due to the performance-based fee structure, it is accompanied by the possibility of increased volatility and risk in the investment strategy. This transparency is crucial in maintaining fiduciary responsibility and ensuring that clients are making informed decisions about their investments.