Practical Financial Advice For Athletes
Financial Information to help you grow your knowledge
Many people have not received the proper financial education in order to understand what they need to do with their money, and this is due in part to the fact that financial terms can seem intimidating and confusing. Athletes due to their spotlight, high earnings power, and often tunnel vision for their careers are particularly vulnerable to questionable/predatory investment practices. Here’s a few things that any person, not just an athlete should keep in mind when selecting financial advice.
Fiduciary vs. Suitability: The Fiduciary Standard was created in 1940 as part of the Investment Advisors Act. This standard, regulated by the Securities Exchange Commission (SEC) or state regulators, says that investment advisors are required to uphold a standard that puts their client’s interests above their own. Advisors are prohibited from front-running their clients, which is buying securities for his or her personal account before buying them for a client. Advisors must due their due diligence to make sure that their investment advice is using as complete and accurate information as possible. Advisors under the fiduciary standard must avoid conflicts of interest or disclose any and all conflicts or potential conflicts that may occur.
The suitability standard is defined as making recommendations that consistent with the best interest of the customer. This may sound the same, but there are some key differences. Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for clients, in terms of the client's financial needs, objectives and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker's duty is to the broker-dealer he or she works for, not necessarily the client served.
Virtually all fee-only advisors are held to the fiduciary standard, however again it is important to ask questions when meeting with a potential advisor and ask if their investment advice is held to the fiduciary or suitability standard.
Risk Tolerance/Asset Allocation: Any advisor should have some sort of questionnaire to find out your individual risk tolerance. Once you and your advisor/potential advisor have sat down and figured out your personal tolerance for risk then they will begin to map out your Asset Allocation plan. Asset allocation is the strategy of dividing your investment portfolio across various asset classes like stocks, bonds and money market securities. No two people’s investing profile are created equal, and your investment strategy should be based on the level of risk that you are willing to take. For example, if you are a very risk averse person and would be extremely uncomfortable with any significant drop in your investment principle. Then you would be much better off using conservative investment vehicles such as Bonds and Certificates of Deposit (CD’s) versus investments in stocks or real estate. In that case you are going to trade potential investment returns for the peace of mind of have very little risk to your current principle. If you are willing to take on more risk of loss to allow for higher investment returns then assets such as stocks and real estate are more suited to be apart of your investment portfolios. One of the biggest red flags that can come up when meeting with potential financial advisors are people who over promise their investment returns and under promise investment risks. There is no such thing as a no risk high return investment. There is a direct correlation to the amount of risk you are willing to take and your potential investment returns. Two things that one should always keep in mind when evaluating financial advisors and their returns: 1) past performance does not guarantee future results. And 2) If it sounds too good to be true, it probably is.
Fees: Another very important question to ask a prospective advisor is how they or their firm structure their fees. In other words, how is this advisor making their money off of you. There are a few different types of fee structures that are used by different types of advisors. There can be an hourly fee, fees based on assets under management (AUM), fees based on investment gains, or a combination of both fees and commissions. Be sure to ask questions on exactly how the fees structure will be set up, because these fees will have an impact on your rate of return over the course of time. For example, if you select an advisor with a 1% flat rate fee with no commissions, and that advisor returns you 10% before fees. Your real rate of return after fees will be 9% (excluding other factors such as taxes and inflation).
Some basics on asset classes and their returns
Now let’s break down some different asset classes and their average returns so that you can have a better understanding of what to look for. The three main investment asset classes are Equities (Stocks), Fixed Income (Bonds), and cash or cash equivalents. Many investment professionals also include other investments such as real estate under the asset class mix.
Stocks: The primary benchmark of stock market returns is the S&P 500 index. Over the course of its history it has had an average return of 9.8%. Since 1950 average returns have been 8.9%. Since 1950 the best yearly return was in 1954 at 45%. Only five times since 1950 has the S&P 500 returned more than 30% in a single year-1997, 1975, 1995, 1958, and 1954. Meanwhile the worst yearly return for the S&P since 1950 was in 2008 during the financial crisis when it lost 38% of its value in one year. There have been only three years since 1950 where there have been losses greater than 20% in a single year- 2008, 1974, and 2002. It is important to keep in mind the risks that come with investing in stocks, returns over the long run tend to outperform other more conservative asset classes (i.e. bonds and cash) however the stock market does go up in a straight line. Markets can be volatile, sometimes extremely so in the short term, and there is a significant risk of loss that goes with investing in this asset class.
Bonds: Bonds are fixed income investments where an investor loans money to an either a company or a government which borrows the money for specific period of time at a variable or fixed interest rate. There are several different types of bonds. The most common types are: Treasuries, corporate bonds, and municipal bonds. Other types of bonds include agency bonds, mortgage backed bonds, and foreign bonds.
Treasury bonds: Are issued by the federal government as a tool to finance budget deficits. Treasuries are back by the full faith and credit of the US government are considered free from credit risk (risk of default), but therefore their yields will always be the lowest. For example, the current yield on the US 10-year treasury note is 2.9%.
Corporate bonds: Debt investments into individual companies. There are two types of corporate bonds: Investment grade and high yield. Investment grade bonds are issued by companies who have a high credit rating- triple B or higher from the ratings agencies Standard & Poor or Moody’s. While investment grade bonds generally carry a low degree of credit risk, they are not back by the US government and therefore are slightly riskier than Treasuries and pay slightly higher yields depending on the individual company.
High Yield bonds: Commonly referred to as Junk Bonds are issued by companies with lower credit ratings and therefore carry a higher degree of credit risk. To compensate for the higher degree of risk involved in their investment Junk bonds typically pay higher yields than investment grade or government bonds.
Municipal bonds: Also known as “munis”. Municipal bonds are issued by either states or local governments. Munis are unique because their interest is tax-free.
Cash: cash and cash equivalents (also called money market securities) are an important part of rounding out your investment portfolio. It is never a bad idea to have at least a little bit of liquid cash on hand for emergency situations or to have on the sidelines to put to work when given an investment opportunity. The term cash and cash equivalents include: currency, coins, checks received but not yet deposited, checking accounts, petty cash, savings accounts, money market accounts, and short-term, highly liquid investments with maturities of less than one year. The most common type of money market securities are Treasury Bills (T-Bills)
Some general investing rules of thumb to keep in mind
Rule of 72: the rule of 72 is a rough estimate of how long it will take for an investment to double based on its annual return. Take the number 72 and divide by the annual return, and the answer is the number of years it will take your investment to double. For example, if you have an investment that returns on average 5% per year. You take 72/5=14.4. So, at a 5% annual return it will take your investment 14.4 years to double. Looking at the historical average return for the S&P 500 of 9.8 it would take approximately 7.35 years (72/9.8=7.346). In 2017 the S&P had a strong year returning 21% so if you were able to sustain those returns it would only take 3.43 years to double your investment.
Inflation: Inflation is the general increase in the prices of goods and services and the fall in the purchasing power of money over time. As inflation rises, every dollar you have will be able to buy a smaller percentage of a good or service. The Federal Reserve is currently forecasting around a 2% inflation rate for both 2019 and 2020. Inflation is an important factor to keep in mind because if you simply keep all of your money in cash, over the course of time that money will be worth less in the future than what it worth now.
Rule of 70: This a useful tool for determine the effects of inflation on the buying power of your current assets. Divide 70 by current inflation rate to know how fast the value of your investment will get reduced to half its present value. For an example, and inflation rate of 2% will reduce the value of your money to half in 35 years. (70/2= 35 years)
These are some basics that any client should have knowledge of before stepping into a meeting with any financial advisor. Having at least some kind of foundation with financial literacy will help to make you a better client, and a less likely candidate for being on the wrong end of a predatory advisor or investment scheme. Remember to always ask questions, and if you do not understand the answers that you are getting, make sure that either your advisor can explain things in terms you can understand or find another one who can. Knowledge is always power in any situation, and when it comes to your own finances it pays to know what is going on.
Jonathan Perrin is a former professional baseball player turned financial advisor. Jonathan was selected in the 2015 Major League Baseball Draft by the Milwaukee Brewers after graduating from Oklahoma State University. His professional career spanned five seasons, including stops in both Mexico and the Dominican Republic. Jonathan became a licensed investment advisor while still an active professional baseball player, with his first clients being his teammates. Post-playing career; Jonathan earned a Masters in Personal Financial Planning from the University of Missouri, and has continued to work as a financial advisor at helping professional athletes and other young professionals manage and invest their money to create long-term wealth.
Disclaimer: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading or distribution strategy. Past performance does not guarantee future results. The accuracy and completeness of this information is not guaranteed and is subject to change. Waterfront Wealth Inc. is currently registered as an investment adviser with the Securities and Exchange Commission.
