In 2009, CNBC held a town hall featuring Warren Buffett and
Bill Gates. Among others in attendance were a few hundred Columbia Business
School students.
One of the most memorable moments from the 90-minute event
was when Buffett turned to the students and offered, “Right now, I would pay
$100,000 for 10% of the future earnings of any of you. So, if anyone wants to
see me after this is over … ”
While there were laughter and applause to be had, surely
some of those students must have sat there and considered his offer. After all,
$100,000 was an enormous amount of money—for people perhaps in their early 20s
at best. Not to mention, many of the students probably even had a negative net
worth at the time due to student loans. They likely thought that $100,000 was
hitting the jackpot!
And yet not a single student took the Oracle of Omaha up on
his offer.
Because they’d been accepted into Columbia Business School
in the first place, these bright-eyed students were considering instead the
high incomes they believed they could achieve over their entire careers. With
that math in mind, $100,000 today in exchange for 10% over a lifetime seemed
woefully underfunded—dare we even say, insulting.
No one took the offer.
Consider a few variables that the students understood:
1. Their long-term earning potential would easily surpass $1
million in the aggregate (the break-even point on the $100,000 up-front offer).
Thus, they knew that if they could be patient and wait for their future income
to arrive, as opposed to taking the “easy” $100K now, they would be better off.
(Yes, we could complicate this math with a discussion about the time value of
money, but eventually the math would still be favorable to a student willing to
be patient regardless.)
2. The students also knew there was a high likelihood that
their annual compensation would increase over time. Thus, taking the 10% deal
now ($100,000) would result in a diminishing return each year.
Buffett would not really be “paying” these students
$100,000. He would simply front them their own money while attaching very
unfavorable terms in return.
Those terms made accepting the $100,000 deal such a
disservice to the students that even if an inquiring student had followed up
with Buffett on it, being the charitable man he is, he would probably renege on
his deal for their benefit.
After all, if Buffett were being completely transparent, he
would have phrased it this way: “I will pay you $100,000 now for 10% of all
your future earnings, no matter how long your career is, and no matter how much
your earnings increase over time.”
The lessons thus learned are:
1. Do not take a quick buck today when being patient is much
more lucrative.
2. Do not take a deal today that is valued on your current
situation (earnings) if you expect your earnings to increase over time.
3. Do not let someone “pay” you with your own money.
What This Means For Advisors
Let’s look at another scenario.
Let’s say you’re a financial advisor thinking of moving your
practice to a traditional broker-dealer. As part of this move, you would
receive a large up-front bonus check. Surely you’ve heard about the large
checks firms have been “paying out.”
So, you sit down with Warren—I mean the local branch
manager—who makes you an offer: The firm will “pay” you $X (perhaps $1 million)
to join. Should you take it?
What if the message were more transparent? Put it this way
instead:
The firm will “pay” you $X (perhaps $1 million) to join in
return for an indefinite 15% to 20% haircut on your production, something you
could otherwise have received yourself under an RIA model. You must stay at
least 10 years, even though we know many advisors end up staying long past
that. Either way, the haircut never ceases.
Furthermore, the broker-dealer is paying you the $X based on
your current production. But we know you’ll likely grow your practice over the
next 10 years or more, which means the haircut gets increasingly lucrative for
the firm (and to your detriment) year after year after year.
The broker-dealer is not generously “paying” you from its
own pockets. Yes, in terms of pure cash flow, in the year it is paid out, the
money is technically “from” the firm. But in effect, the firm is simply
advancing you your own future earnings, something you could have otherwise
earned yourself under an RIA model. And for that, they are attaching equal, if
not worse, terms than Buffett was offering the students.
We could dive further into the details and talk about the
time value of money, taxation, etc. But make no mistake, the math always favors
the firm. You’re not being offered those checks out of the kindness of
somebody’s heart.
A casino will always allow you to make a quick buck today
because the owners know the long-term odds are always in their favor. The math
is no different with up-front recruiting checks.
Perhaps the firm you want to join is appealing for other good
reasons. But just as Buffett’s seemingly generous offer did not blind the
Columbia students, do not be blinded by seemingly generous up-front recruiting
checks either.
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