This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
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Every July 1, the New York Mets pay Bobby Bonilla $1,193,248.20. This has been occurring since 2011 and will continue until 2035. Bonilla has not played for the Mets since the 1999 season and hasn’t played baseball since 2001!
Why is he receiving those annual checks?
Before the start of the 2000 season, Bonilla had $5.9 million remaining on his contract. With his performance slumping, the Mets wanted to buy out his contract.
Instead of cutting a check for the $5.9 million, they agreed to pay him ~$1.2 million a year between 2011 and 2035. That is almost $30 million in aggregate! Bonilla accepted.
What’s the catch?
For the Mets, they didn’t have to immediately ante up the $5.9 million. They postponed payments into the future. In an unusual twist, the then-owner of the Mets was heavily invested with a hedge fund manager named Bernie Madoff. Perhaps they thought keeping the $5.9 million invested would pay off in the long run!
For Bonilla, if he was willing to be patient and wait a full 11 years to receive his first payment and 35 years to receive it all, he would, in aggregate, receive far more than the $5.9 million originally owed. It helped that Bonilla had been a professional athlete for many years by that point and presumably (hopefully!) had saved prior earnings along the way. But his patience is paying off in spades!
What can financial advisors learn from this? Be patient when it is to your advantage to do so.
Consider the upfront bonus checks often paid to advisors leaving one broker/dealer to join another.
That “bonus” is not a bonus at all.
The seemingly generous broker/dealer is not paying you any of their money. They are advancing you your own money, in return for an indefinite lower payout than you could achieve in other affiliation models, less flexibility for your practice, and handcuffs stretching out 10+ years.
Imagine if Bobby Bonilla was in our industry and had two offers in front of him:
Option A: Receive a reasonable upfront bonus, have a 45% payout indefinitely, and be required to stay at the firm at least 10 years; or
Option B: No upfront bonus, 65% effective payout indefinitely, more flexibility, and no handcuffs on how long he must stay with the firm.
Bonilla realized he did not have an immediate need for liquidity. He could afford to be patient and play the long game.
Which path would he choose?
Which path would you choose?
It is a nice feeling to get that upfront “bonus” check in your pocket. But if you can resist the initial dopamine hit, the long-term aggregate math rewards the patient approach. Broker/dealers are not being generous. There’s a reason they structure it as they do.
Hold on now, Brad!
What about the time value of money?
What if the upfront check was invested over the balance of the 10 years?
What kind of growth rate are we assuming for the practice over time?
What length of time are you assuming the advisor will stay in the industry?
What option pays 65% vs 45%?
All good questions to consider and answer.
How many advisors take the time to run those calculations though?
If Bonilla did the math (as he surely did), he would have known that the net present value of the $1.2 million payments, discounted at 10%, was more than $10 million in 2000 – almost twice the $5.9 million he could have had then.
A wirehouse will gladly come along and offer a big upfront check. They won’t, however, break out a spreadsheet to map out the rest of the math to show you how their aggregate math compares to the aggregate math of other options. Big shiny checks make that all unnecessary.
If you are an advisor who took a check, or are considering taking one, did you consider other options? Did you run the math to determine how the options compare economically not just in year one (when the shiny check arrives), but over the balance of your career? And at a minimum, over the handcuff period you must agree to in return for the check?
Let’s also not overlook the higher valuations and advantageous tax treatment certain paths will reward you with for your eventual end-of-career liquidity event. Have you factored that in as well?
There is no universal answer as to which affiliation model or firm is better than another. There are numerous tangible and intangible variables that need to go into comparing such options, complicated further by the uniqueness of each individual advisor’s practice.
Being blinded by a big check without fully comparing it to other options is playing the short game.
Bobby Bonilla played the long game.
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.