From the March 2009 issue of Investment Advisor • Subscribe!

The Fast Track: Collective Amnesia

Why don't more independent advisors anticipate market downturns?

I started my consulting career in 2001--not exactly what you would call optimum timing. The dot.com crash had taken trillions of dollars out of the economy and advisory practices were struggling with falling revenues from lower assets under management and the resulting higher workload from needier clients. Sound familiar?

Becoming a consultant during those difficult times was actually a tremendous blessing. Not only did many practices need help, but I got a bird's eye view of what makes some practices succeed and others struggle, at a time when those differences were of utmost importance. Consequently, my goal has always been to help independent advisors build recession-proof practices.

These days, it seems everyone is asking me: Why do advisory practices fail? From my perspective the answer seems quite simple. For reasons that can only be explained to my mind as one facet of human beings' seemingly infinite capacity for denial, advisors--like the rest of the financial services industry and the investing public--tend to believe that when the economy is good and markets are going up, they will always continue to do so. Instead, not only do they refuse to position their firms for times that might not be so good, they seem to go out of their way to overexpose and overextend their practices so that the slightest downturn becomes a challenge and times such as we're having now become catastrophic.

Let's have a little historical reality check, here. Now, this is a little before my time, but I've read that the financial planning movement was born in the late 1960's when the "go-go" stock market up and went and formerly high-flying mutual fund sales folks started looking for a better way to help their clients--and make a living. Since then we saw another recession in 1979, a market crash in '87, the mini-recession of '91-'92, the dot.com crash of 2001, and the Credit Crisis of 2008. That's six severe down markets in the past 40 year-history of financial planning, or roughly one every seven years or so.

That means the economy and the financial markets are going up about 85% of the time and steeply down about 15% of the time. It also means that during the good times, (which if '81 to '87, '88 to '91, '92 to 2000, and '01 to '08 are any indication, are great for the business of independent advice) the question is not "if" the markets will eventually tumble, only "when?"

I'm as Clueless As You

So how can rational financial advisors, who assess their clients' tolerance to the risk of market downturns and create diversified portfolios to protect assets against market downturns, consistently fail to plan for those same market downturns when managing their own practices? Don't look at me: I'm as clueless about this one as you probably are.

Yet, rather than assume that every seven years or so, the markets will tank like the Chicago Cubs in September, advisors happily hire employees, move to fancier offices, add partners, buy technology, discount their fees, and anticipate selling their practices, all seemingly based on projections using their then current well-into-double-digit growth rates. What's more, because those "never-ending" good times are so good in the advisory business, advisors who are suddenly making way more money than they ever expected to make don't concern themselves with growing expenses, anemic profit margins, haphazard operations, underperforming employees, low staff moral, high employee turnover, lack of financial controls, vastly underutilized technology, uneven client service, or over-priced custodians or B/Ds. If they run into a problem, they can always solve it by hiring some more folks. And good luck to any consultant who tries to tell them otherwise.

When the markets inevitably went south, and fee revenues fell, many of these practices were in for hard times. As I've written before, unlike most industries, when advisory revenues fall, the workload actually increases due to the need for more (not less) client hand-holding. Without the revenue growth to hire more help, inefficient, low-margins firms find themselves in a real pickle during down markets.

Use Your Experience

I wrote last month about quick steps that advisors can take to get their practices under control and positioned to prosper once the markets turn again. I also like to suggest that once you stop the bleeding, and the anticipated recovery gives you a little breathing room, it will be time to use this experience as a launching pad to build a truly recession-proof practice so that you'll be one of the firms that prospers when the markets predictably fall again. The first step, of course, is to fight through denial, and actually anticipate a market downturn. Then, consider:

Create high margins. Even though Communism fell with the Berlin Wall, we still seem to have ingrained into our culture the Marxist principle that profits are bad. A healthy profit margin in your practice isn't greed, it's a necessity. Just as you tell your clients to set aside a substantial cash reserve for times like these, your profit margin is your firm's reserve. Practices with higher margins have the option to reinvest if necessary, or add more help to smooth out uneven workload. A good profit margin also means your expenses are under control, which is more important than ever during tough times.

Systematize everything. The rule of thumb is: if you do something more than twice, make a system for it. Treating client service from quarterly reports to rebalancing portfolios like it's the first time you've ever done it is more than amateur hour--it turns your firm into Beavis and Butthead's Big Adventure. The most efficient practices have a clear process for handling every step required by existing and prospective clients. This requires less staff, creates less stress, higher employee satisfaction, and offers much greater excess capacity for when the horse-hockey hits the fan.

Design a sound revenue structure. One of my first observations in 2001 is that fees based solely on AUM are too variable during down markets. I advise my clients to create a hybrid structure based on roughly 50% AUM fees and 50% flat annual retainers. After all, you usually do more work, not less, when assets fall. The retainers can be calculated based on each client's assets or financial complexities, but having half your revenues set as a fixed fee sure smoothes out the ride when the rollercoaster is going down and gets you paid for the financial planning advice that you are giving outside of the investment management.

Streamline client communications. In this electronic age, there is no excuse for not maximizing the available options for client communication: e-newsletters, e-mail blasts, video conferencing, Webcasts, conference calls, etc. can all greatly reduce the time and effort involved in client communications. When you're going to tell all your clients the same thing--such as your take on the markets or the economy--why not tell them all at the same time? It makes you look high-tech and creates a sense of community among your clients. When client communications are regular and automated, increasing the frequency as required by troubled markets will be a snap for you as opposed to the snafu it creates at most firms.

Segment service models. The most sophisticated advisory practices realize that all clients don't require the same level of service. Some clients have more complex financial situations, and hopefully, pay more for a higher level of service. And no matter how hard we try, there seems to be no way to avoid a smattering of relatives and friends who don't need more than life insurance and to dollar-cost-average into a few mutual funds. Either way, you and your staff need to clearly know what services your firm will provide to each client. Not only does that make systems and fee structures much easier, but when the workload starts to increase and resources are stretched thin, segmented services models makes it much easier to see where you need to focus your firm's efforts.

Target your clients. I know that having targeted clients has become almost a clich? in the advisory industry, but there's a good reason for that: few things will make your practice more efficient than working with clients who all have the similar finances and needs. Your range of services and products will be significantly narrowed, and consequently the expertise of you and your staff will be greatly increased. What's more, your marketing efforts, or simply referrals, will be magnified when focused on a tighter group.

When times get tough, these efficiencies will really boost your practice. So will knowing which clients you absolutely want to keep, and which of the new clients who come knocking you absolutely want to take.


Angela Herbers is a virtual business manager and consultant for independent financial planning firms. She can be reached at angieherbers@cox.net.

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