From the June 2007 issue of Investment Advisor • Subscribe!

June 1, 2007

Up and Out

A newly independent Mike Patton learns some lessons and wins clients

There's a big difference between imagining independence and being independent. In the first few months of my new life as an independent advisor, I've had my share of false starts and surprises, and I've come to have a greater appreciation for the independent practitioner. In fact, I believe that if it were possible to marshal the talent and wealth of knowledge held by the independents of this world, it would rival, and perhaps even surpass, that possessed by the largest of institutions. But perhaps I'm getting ahead of myself--so let's go back to the beginning.

In my first article on becoming an independent advisor, in the April 2007 Investment Advisor ("Plotting Your Course"), we focused on the preparation phase: how to determine your target market, choose the products and services to offer, and calculate the start-up costs, even how to name your firm (mine is Integrity Wealth Management, in Baton Rouge, Louisiana). In this one we will focus on those first few months of independence. I will share some of my experiences with the hope that they will offer encouragement to those of you who may be considering making, or have recently made, the move to independence. Over the past few months I've received a number of e-mails from readers. While some offered advice and others asked for it, all of you have been very encouraging to me in this new endeavor, and for that I'm grateful. Through my accompanying blog, The Road to Independence, at www.investmentadvisor.com/blogs, I've received tips from readers and even renewed a few old acquaintances. I have also heard a common theme echoed from advisors who've left large firms, "I wish I had made the move sooner."

I've learned there are a number of independent advisors who are willing to share their stories. This creates a tremendous potential for synergy, which led me to the conclusion I shared in the first paragraph above about the power of independents to challenge institutions. Let's not forget that at one time, even these large institutions were nothing but a dream, founded by independent, free thinking individuals, who pursued a vision. But, many have evolved into bureaucracies that can make it difficult for advisors to serve their clients in the way they deem best.

The Benefits of Freedom

I am discovering that owning your own business has many perqs, beyond the obvious financial potential. For instance, you're responsible for determining your own schedule. It was this "freedom factor" (sounds like a new reality TV show) that attracted me in the first place. The ability to come and go as I please has been very liberating. I can decide which client engagements to accept and which ones to decline. There is another side, however. Owning your own business involves a great deal of time and effort, especially in the beginning. I think of it as a "pig in the snake" metaphor: As it digests, it gets smaller. In these early days I've found myself searching for a custodian for my client's assets and looking for a master general agent for the insurance business I will do while continuing to pursue new clients. I have also been working with a graphic designer to develop marketing materials. Beyond this, as a registered investment advisor I have to put client agreements together, and create policies and procedures and compliance manuals. Even though it's been very time consuming, once the initial tasks are settled (the pig is getting smaller), the majority of my time will be spent on acquiring and servicing my clients. Independence is obviously very different from working for a major corporation. When you own your own business there are a lot of decisions to be made, and no matter how prepared you may think you are, there are always a few unexpected potholes in the road.

RIA or B/D?

I gave a lot of consideration to operating my business as an RIA, affiliating with an independent broker/dealer, or being dually registered. After much thought, I decided to become an RIA. The reasons I chose this path--having to do with freedom issues, and financial ones--are chronicled in more detail in my blog. But the lessons I learned in the registration process could prove to be a time saver for any of you embarking on the same journey. First, you have to register through the Independent Advisor Registration Depository (IARD) portal located at www.iard.com. You must register with the state or the SEC, depending on the amount of assets you have under management. Currently, the threshold is $25 million, at which point you must register with the SEC (though that level is under review, I understand). In any event, if you're under the threshold you register with the state, which is what I did. The annual fee in Louisiana is $150 and a 25 lb. bag of crawfish (just kidding about the $150). All kidding aside, it really does cost $150 per year. The fee to register with the SEC is $1,000 each year.

You'll need to fill out forms ADV part I and ADV part II. You could hire someone to fill them in or do it yourself. I chose the latter. The IARD portal contains forms ADV I and ADV II. Both are online forms, and the entire exercise can be a bit challenging. The forms themselves are fairly well organized but you'll need to know something about the definitions so you can answer the questions correctly. It's also very important to perform a completeness check before you submit. This informs you of any incomplete items in the form and is where I took a wrong turn. I filled in the ADV I and thought I'd submitted it. As it turns out I didn't, and my registration was held up as a result. Had I known to perform a completeness check, I could have expedited the process. According to a specialist at the IARD helpdesk, the most common mistake advisors make in the process is a general lack of knowledge of the IARD system. The moral of the story is to allow ample time to become familiar with this process prior to registering. You might consider reading The RIA's Compliance Solution Book written by Elayne Demby (Bloomberg Press, 2006) which has a wealth of information for the RIA. If you need assistance maneuvering through the IARD, you can call the helpful folks at its helpdesk--240-386-4848.

Infrastructure and Technology

Although hair loss is largely heredity, if it were possible I would blame mine on the recent technology glitches I've experienced. Specifically, I purchased a new Dell laptop with Windows Vista as its operating system, reasoning that in the near future I would have to upgrade anyway. For those of you who are extremely tech savvy, if you're not already laughing hysterically, you may want to skip this and proceed to the next section. For the rest of you, a piece of advice: If you are contemplating an upgrade to Windows Vista, or perhaps purchasing a new computer with this operating system on it, you may want to rethink it. My first problem with Vista occurred when it would not print to my new Dell color printer. At the time, it seems Dell hadn't created the printer drivers to allow this. Dell has since corrected this. Also, I could not print from certain programs while connected to the network. I could print to my wireless printer but not through the network. According to the owner of a local computer shop, which I confirmed with a Dell representative, Microsoft initially required every new machine sold to have Windows Vista as its operating system. Due to a large number of complaints (myself included), Microsoft has relented and now allows a choice of either Windows Vista or XP. Also, if you have Windows Vista on your computer, you may qualify for a free downgrade to XP. I just downgraded my system to XP Professional. I paid a local technician $65 for his labor--I was very satisfied with his work and plan to use him in the future--but did not have to purchase an XP license. Now my technology is working great and my hair is even growing back.

Fee Setting and Services Offered

To outline the services I will be offering, let me first explain the four different levels of service I plan to offer.

Level I is for the business or individual who needs to make a specific decision on a particular issue. For example, let's assume a developer of assisted nursing facilities is contemplating building a new facility in eitherDallas, or New Orleans, and the decision will be based on the net profit potential. Typically, they will use an spreadsheet model to run a series of "what if" scenarios. I will use their model and add Monte Carlo simulation to forecast the probability of success for each location. Equipped with this new information, they will be able to make a more informed decision.

Level II is portfolio management. As an RIA, I will operate on a fee basis. I'll have the flexibility to base the fee on a percentage of assets, a flat amount per year, or any other method to which the client agrees. The SEC will not allow a "performance-based fee" (a concept too lengthy to address here) but a percentage of the account balance is fine. The fees, whatever they are, should be clearly articulated to the client.

There has been, and continues to be, much discussion around the value that active management brings to the investment process. I do not believe that one should invest all of their financial assets in a passive strategy. I don't believe it's a bad strategy, it's just not the best one. It's clear that some managers do in fact, add alpha. If this were not true, then the alpha on all funds would be below zero the majority of the time. In reality, many managers consistently demonstrate a positive alpha. I plan to use a combination of passive and active strategies, keeping the fees as low as possible.

Level III is comprehensive financial planning. In this level I will use a process commonly referred to as life planning, a process that begins by getting to know the client as a person before you discuss what they own. You discover their values and learn how they make decisions. In the first meeting, we never discuss what they possess. In my practice, the process of creating a financial planning document and developing recommendations involves a series of meetings, typically held over a 30-60 day period. Beyond that, the relationship is one of providing ongoing advice and reviews as needed. For this service I will charge an annual retainer fee. Financial planning, as I see it, is not a one-time event but a dynamic process that continues throughout the client's lifetime (see sidebar, "A Planner's Got to Know His Limitations," page 76).

Level IV is a combination of Levels II and III. Here I will discount the asset management fee since I'm receiving an annual financial planning fee. This level involves a significant commitment to the client. Besides the asset management and comprehensive planning services, they will receive certain additional services which they are probably not receiving anywhere else. This added value is driven by the client's need to simplify their life so they can enjoy the fruits of their labor. The reason this is vague is that it's currently in the developmental phase. I'll expand upon this later.

Gaining a client's trust and confidence is the most important thing you can do. You accomplish this by always placing their interest ahead of your own. This means, if you're managing their portfolio and they ask you about buying a piece of real estate--income producing or not--you must be willing to render an objective opinion, even if it means you will lose assets. The key is to always do the right thing for those you serve.

Getting Clients, Finding Space

In my first month and a half, I have added three new clients. At this point, two of them are Level III and one is Level IV. I hope to add two to three new planning clients each month until I reach a point where I'll need to add staff. Initially, I planned to send out a mass mailing and still may, but for now I'm using a narrow segment marketing approach. If I do a great job for those I work with, and get the word out to various centers of influence, they should keep me busy with referrals. Also, I don't want such a large number of clients that I won't be able to provide the high level of service they are paying me for.

My office is located in a suite of offices called Executive Suites. We all share a common receptionist, copier, and the rent is very reasonable--about $650 to $700 when you include my two telephone lines. Here's the really interesting part. The person who owns this is a friend of mine and is in the business. We met about 10 years ago when we worked together at a large wirehouse. There is the potential for a partnership since we trust each other and provide complementary services. He provides clients with business consulting, cash flow analysis, and looks for any inefficiency that may be present. He has also adopted what would be referred to as a satellite asset management strategy. I, on the other hand, provide comprehensive financial planning for individuals, with a core asset allocation approach. The key to this potential symbiotic relationship will be our ability to mesh our personalities together into an efficient working relationship. I'll write more on this online and in the next two installments of my report to you as I proceed down this path. For those of you looking for assistance or for those of you willing to offer advice, I would ask you to join the conversation through the blog located at www.investmentadvisor.com that you can access by clicking on the photo of the follically-challenged advisor.

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