Don’t Let the Kentucky Derby Pick Your Advisor

Horse racing can be a lucrative business.  This year’s Kentucky Derby winner will bring home $1.86 million.  The first Saturday in May is the only time America (outside of Kentucky) pays attention to horse racing.  This might be stretched out to several weeks if the same horse wins the Preakness Stakes, setting the table for a possible Triple Crown at the Belmont Stakes.  “The most exciting two minutes in sports” garners intense buzz, but is quickly forgotten.  Too many investors adopt the same strategy for choosing financial advisors.

The Horse Race

The investor allocates a little money across three or four potential advisors.  Whoever has the highest returns at the end of 6 months or a year gets to manage all of the investor’s assets.  In the biz, we call this a horse race.  The investor thinks they are choosing a financial advisor, but is this really the way to evaluate the person that’s supposed to help achieve long-term (10+ years) financial goals?  What they’re really doing is incentivizing short-term risk-taking.  There is no risk for the participants to be as aggressive as possible since even if they lose, they still get to charge the investor while they are managing the assets.  If they win, that’s more assets for them to bill on and they will likely change their strategy so they can bill on those assets for as long as possible.  Note I focused generating revenue for the “advisor”.  That’s because the people who participate in horse races are more often asset gatherers than true financial advisors.

After the Race

The public gets caught up in the tradition and ceremony of the Kentucky Derby.  The race is exciting and we hear all about the purse and what the payout would have been if you had bet $100 and hit the trifecta.  However, the real money is made after the race and it turns out that winners on the track aren’t always winners over the long-term.  Let’s look at race winnings from three different (yes, very cherry picked) horses.  Horse A won $570,000 over his career.  Horse B won $557,000.  Horse C won $3.5 million.  So who was the best long-term investment?

Horse A is Storm Cat, a horse you’ve probably never heard of.  Storm Cat didn’t have the look of a champion – he was not tall, had a short neck, and offset knees.  After he was done racing, his stud fees were $30,000 and his owners had a difficult time finding mares to breed him with.  Then his foals started winning.  Storm Cat’s stud fees peaked at $500,000 and his highest priced foal was sold for almost $10 million at auction.  His post-racing career lasted 21 years.

Horse B is Tapit, another horse you’ve never heard of.  Bought as a yearling for $625,000, he has career winnings of $557,000.  Tapit now commands a stud fee of $225,000 and has had 26 foals sell for $2 million or more at auction.

Horse C is War Emblem, winner of the 2002 Kentucky Derby and Preakness Stakes.  He almost completed the Triple Crown, but lost the lead at Belmont after the final turn.  War Emblem is obviously the best race horse of the three choices.  So how much are his stud fees?  $0.  He was sold to a Japanese breeder for over $17 million, but they had difficulty due to War Emblem’s “lack of interest”.  In 2015 he retired back to the United States, but refused to breed with two mares as part of a test for disease during quarantine.  He had to be gelded.

Horse Racing Can Make You a Small Fortune

This is not to say that everyone who puts advisors in a horse race will end up with a disinterested War Emblem.  If part of the horse race evaluation is how the advisor fits personality-wise and the investor is willing to pony up (I had to) and pay several advisors at the same time, maybe that can work.  Maybe one of them will be the advisor equivalent of California Chrome (career race winnings of $14.8 million).  However, when selecting an advisor, it makes more sense to take into account things like whether they are a fiduciary, how they get paid, what their fees are, what’s in their ADV, what their brokercheck looks like, whether their strategy is a good fit, and whether they fit personality-wise.  Better yet, ask around.  Your friends are the best resource for honest reviews.  The reality of focusing on the short-term to choose a long-term financial advisor can be summed up with a horse racing adage: To make a small fortune in racing horses, start with a large fortune.

Photo by Traveloscopy