Properly Assess the Financial Risk Associated with Your Compensation Plan

Properly Assess the Financial Risk Associated with Your Compensation Plan

Properly Assess the Financial Risk Associated with Your Compensation Plan

In the last blog post, I explained that you are the CEO of your Golden Goose Management Company. One of the most important aspects of the job of a CEO is risk management. CEOs naturally think in terms of risk and try to minimize it financial risk whenever possible.

As the boss you need to view financial decisions and compensation plans in terms of risk. This is another principle that I have had to learn the hard way and I hope you can learn from my mistakes instead of repeating them on your own.

There are two basic compensation plans that I want to use to convey this concept of risk. One compensation plan is where the monthly compensation is paid up-front and the other is paid after the work is complete.

For instance, the Super Star that I referred to in the last principle demanded that I pay a very large sum UP FRONT and that would cover one month’s work. If things didn’t work out as planned, I am out that money that I paid.

The other compensation plan is where payment is made after the work is done. This is how I work with all my other contractors. We agree upon a set wage and when the payments will be made. For instance, the Super Star and I might agree to a wage for the month, payable at the end of each month.

As the CEO, which compensation plan has more risk for my company? Obviously the first one does. If I hand over the money and the Super Star doesn’t perform as expected, then I have LOST that money. I have little chance of getting any of it back.

In the second compensation plan, I am not paying for the work until AFTER the work has been done. If the Super Star only works 1 week, then I will only pay for that one week.

When I pay the a large sum up front, I have a large sum at risk and it is possible that I can lose all of that. When I pay the that same amount after the work is done, I have avoided that risk. Which is better for my company?

Keep this in mind when dealing with a financial advisor to help you with your Goose that laid the golden egg. There are many products out there like annuities that make you pay for service UP FRONT. For instance, if you put your money into an annuity and change your mind, you aren’t going to get all of your money back.

The money that you don’t get back basically amounts to the commission that you paid.

If you invest $500,000 in one of these fancy annuities, you are basically paying $30,000 – $40,000 or more upfront to a contractor that hasn’t done any work for you yet. If things don’t work out—for whatever reason—then you have LOST that money. You will NOT get it back.

Some may argue that buying an annuity is like buying an item like home or a vehicle. In both of those cases you are paying the commission up front. So what’s wrong with doing that in an annuity?

The biggest concern that I have is that many of the annuities being sold to retirees nowadays have all these special features like a 7% income guarantee and those riders are the main reason someone is buying it.

When you buy a house, you know what you are getting. You can have a home inspection done that will uncover any hidden pest damage or mold problems. You can have the foundation inspected. So when you commit to buying that home you know what you are getting.

If you buy a new car or a truck, there is a warranty associated with it that protects you from manufacturer defects. If the engine stops working a month after you buy it then the warranty should cover it.

In both of these examples, the compensation risk can be mitigated or reduced. It is very hard for the average investor to mitigate the risk associated with buying one of these annuities because they are very complex contracts that are even hard to professionals to dissect. And all of these fancy riders all come with clauses and conditions that often result in them working far different from the way many agents seem to portray them.

You have to recognize that you have a significant amount of compensation risk when you buy one of these products.

There are advisors, like myself, that don’t earn a commission on the money they manage on your behalf. Instead, they earn a fee. They only get paid for the period of time you have them manage your money. It is like paying an employee at the end of the month instead of the beginning of the month.

There is less risk to your goose that laid the golden egg if things don’t work out as planned or you just change your mind.

Your responsibility as CEO of Golden Goose Management Company is to closely manage risk. When you consider hiring someone to help you, take into account the compensation risk involved and, whenever possible, opt to pay someone after they do the work instead of before.

The fourth Common Sense Core Principle of Retirement Investing is to recognize and take into account the risk associated with the compensation structure of the ‘employee’ you are hiring to help you.

Feel free to let me know what you think about the information presented in this series—you’re feedback will allow me to make it better. And your comments and questions will help others, too..

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