Given their lack of experience with financial markets and the standard of care provided, professional athletes picking a financial advisor should typically choose to pay a percentage of assets to a registered investment adviser as opposed to commissions to a broker.
In order to get the most of this more expensive option, an athlete must take advantage of all the financial planning this adviser can offer, including estate planning, debt planning, tax efficiency, budgeting, and taking your specific goals into perspective.
A few weeks ago, I wrote an article about the stark differences in the standard of care between a broker and an investment adviser. To quickly recap: the financial recommendations by a broker do not have to be in your best interest but only suitable, and the financial recommendations by an investment adviser have to be in your best interest.
There are nuances to this, such as dually registered investment advisers, so please refer back to the article for more information.
Despite my good intentions, the article failed to address the costs associated with brokers and investment advisers. Basically1, there are four ways you can pay for financial advice:
- Commission: For every buy and sell, you pay a commission. This is usually a percentage (not more than 5% for publicly traded securities) of the total dollar amount of the trade or a flat rate.
- Fee-only: A flat-fee (ranging from 0.25% - 2.0%, averaging 1%) of your invested assets (cash is usually not charged) under management. Registered investment advisers charge a flat-fee2, and as this report shows, some brokers are moving towards fee-only as well.
- Fee-based: This is a hybrid where the financial advisor receives fees on your assets and commissions on products she’s incentivized to sell, such as load-based mutual funds, annuities, and insurance.
- Hourly: Pay by the hour for specific financial advice (estate planning, tax-advantaged investing, retirement planning) with rates varying widely. Sometimes “fee-only” investment advisers will also offer hourly rates.
An astute reader asked if it was better to pay an advisor hourly or pay a percentage of money under management?
I responded to him (paraphrased and supplemented here) that it depends on a number of factors, including:
- Your own understanding of the market, investment products, fees, and emotions. As Warren Buffet said, “the greatest enemies of the equity investor are expenses and emotions.”
- Your ability to monitor your financial advisor's investments and activity.
- The goals you're trying to accomplish (i.e. are you only investing or do you need a full financial plan which includes estate planning, retirement planning, budgeting, etc).
We're All Different
The costs you pay should be based on what you need, and every person’s financial world is different. Take myself as an example. Since I was a kid, I’ve been interested in the stock market and how the financial world worked. In college, I majored in Finance (and English - go humanities!), interned for financial firms, worked after college at Merrill Lynch in wealth management where I eventually became a broker, and then became a financial regulator for seven years.
I worked and invested through market collapses (I remember being at Merrill during the Flash Crash and seeing huge blue chip stocks drop enormous percentages in minutes) and crazy bull markets (we’re still going since the crash) and got to understand the role my emotions played in investing and how to remove them as much as possible.
These experiences led me to invest my own money today, so instead of paying large commissions to a broker or a percentage to a registered investment adviser, I pay very small annual expenses to Vanguard (averaging around 0.10% of my invested assets per year) for my handful of index investments.
In the event I need estate planning or other expertise I don’t have, I will pay an hourly fee to a licensed professional for those services.
What Should Pro Athletes Do?
Compare my experience with a typical professional athlete, someone who has spent his or her life perfecting their athletic craft instead of their financial prowess. Coming into the pros, his or or her understanding of the markets is minimal, his monitoring (and understanding) of an advisor's activity will also be minimal to non-existent, he will not have experience controlling his emotions in turbulent markets, and he will not understand the fee structures of products. Therefore, he will most likely need a holistic approach and guidance to his specific goals and finances.
In that case, paying a percentage to a fee-only registered investment adviser who is solely acting in your best interest is likely the safer bet.
Milk Every Cent Out of That Percent
A pro athlete investing $5 million will pay his adviser roughly $50,000 per year at a 1% fee (these fees can also be negotiated down based on the amount of assets, so it’s certainly possible to pay less than 1%). If you’re paying that much, you should receive more than just management of your investments.
You advisor should develop an overall financial plan that over time will include estate planning, retirement planning, education plans for children and family, budgeting, tax-advantaged investing, lending, and a continual education in the world of finance. Take advantage of every resource you can get from your advisor because you’re paying for it either way.
As the brilliant Ben Carlson wrote, there are differences between investment management and financial advice. Paying an investment adviser a percentage, you should get both.
Don't Want To Pay A Percent?
If you're weary of paying a percentage and prefer a broker, you must have the financial knowledge that your broker may sell investments in her best interest and not yours. Paying on a per-trade basis would drastically reduce your costs if your advisor trades sparingly in low-cost investments, but there are also risks with brokers (there are risks with investment advisers as well), including churning and incentivized selling. There are also risks with your own understanding and review of the broker's activity. So tread carefully.
In the End
There are many different factors that will influence your choice of a financial advisor. Costs and standards of care coupled with your needs should be at the top of the list.
1 - Please do not get me started on ALL of the costs embedded within trading, particularly with active investments and/or alternative investments (management fees, operating expenses, performance fees, turnover and tax costs, finders fees, etc.). Here is a pretty understandable explanation of the difference between active investing vs. passive investing.
2 - Make sure firms that claim they are “fee-only” really are. As the informative Michael Kitces pointed out in 9 Out Of Top 10 CNBC “Fee-Only” Advisory Firms Not Actually Fee-Only?, many self-proclaimed “fee-only” firms have affiliated insurance companies that charge commissions. Nothing wrong with providing insurance, but if you’re making commissions off your customers with these affiliated products, you’re not “fee-only” and may run into some conflicts of interest for your clients.