Incentives

Though it doesn’t happen as often as it used to, from time to time I still meet potential clients who say something like, “I’ll test you out for a year. I’ll invest X dollars with you, Y dollars with another advisor, and invest Z dollars myself. At the end of the year, whoever has the best returns is who gets all the investable assets.”

When I was a brand-new advisor, I’d take on these clients. Every dollar of investable assets is important when you’re building a wealth management business from scratch. I won a lot less than half of the contests, and the contests I did win were due to luck, not skill.

I will never take on a client like this again. Knowingly or not, these kinds of potential clients and the contests they create result in errant incentives.

I know I’ve said this before, but it bears repeating: no one knows if the market will be up or down over the next twelve months. No one. I don’t care if they predicted both the Tech Boom and Bust and the Great Financial Crisis, or if they have three PhDs, or if they have a $50/month investment newsletter. No one can predict short-term market movements.

How the heck are you supposed to win this contest if it’s a coin flip? If you think the market’s going straight up, you chase high-risk, growth-oriented investments. If you think it’s heading down, you pile into ultra-conservative, interest-bearing assets. Either way, you ignore the client’s goals, risk tolerance, and time horizon.

What happens if you’re wrong and you bet on growth, but the market tanks? Well, the client takes a dirtnap*. And if you go conservative and the market soars? The client just missed out on sizeable returns. Either way, the client loses.

And what if you’re right? If you’re right, you’ll think you can do it again. And again. And again. But you can’t. Eventually, you’ll be wrong. I’ve seen colleagues and competitors ride the wave for two, sometimes three years. Their clients love them until the luck runs out. When the streak ends - and it always does - clients are left disappointed, often with portfolios that don’t match their goals or risk tolerance.

Advisors, please don’t play this game because you’ll lose every time. Focus instead on what’s important. And clients, think carefully about the errant incentives you’re creating.

*This is a term we use for a catastrophic portfolio drop.