From the October 2010 issue of Investment Advisor • Subscribe!

Show Yourself the Money

Advisors need to learn to pay themselves first

I had a former client who constantly complained about his income and the profitability--or lack thereof--of his practice. He had good reason to be unhappy: while having a good client base that generated AUM fee revenue of around $500,000 in what you would call a "solid" small business, he only took home $40,000 of that.

The problem was that he had to buy "the best" of whatever he bought, from computers to office furniture, and he bought lots of stuff he didn't need at all. This proclivity included periodically remodeling his perfectly nice offices, and a state-of-the-art, professionally designed and produced e-newsletter.

Like far too many advisors, his real undoing was his staff, to which he continually added, despite the fact that his current staff was complaining that they couldn't find enough to keep them busy. Our relationship ended when he added a senior advisor at $80,000 a year, apparently in anticipation of client growth for which we hadn't seen any evidence. I realized I wouldn't be able to solve his problem until he was ready to be helped.

As a business consultant to independent advisors, I've found that one of my primary jobs is to protect the income of my clients--from themselves. For reasons that may require a psychological analysis far beyond these pages, I've found that many advisors have a pronounced tendency to spend their firm's revenues almost as fast as it comes in the door. Maybe it's because they suddenly find themselves making far more money than they ever expected. Maybe it's because, without a formal business background or education, some advisors don't realize how quickly any business's profits can be eaten up by small, but steady, uncontrolled expenses. I suspect it's probably a little of both.

Yet I've also found that when an advisor isn't happy with her or his income, their enthusiasm for their practices wanes, along with their motivation--and the business suffers. To have a successful firm, it's important that owners feel adequately compensated for the time and effort they're putting in, that they're happy with their income. Ironically, most financial advisory firms do generate enough revenue to adequately compensate their owners. They just waste so much of it that they can't affort to pay themselves what they deserve.

The Four Forms of Overspending

Overspending in independent advisory firms usually comes in any or all of four main areas: People, technology, client services, and facilities. As you might expect, people (that is, both professional and non-professional staff) typically make up the largest portion of a firm's overhead, and are also typically the most mismanaged. The problem has been exacerbated in recent years by countless business consultants extolling the necessity of "leveraging" advisors with support staff, under the theory that support staff is relatively inexpensive, and if more expensive advisors can be leveraged to handling more clients, revenues and profits will go up.

In theory this makes sense. In practice, the efficient use of support staff can, and will, increase the productivity of an advisor and the profitability of his or her firm. As is the case in virtually every aspect of business, however, the devil is truly in the details. In this case, attaining this magic "leverage" can be a little trickier than most consultants let on.

The rub? In creating this so-called leverage, even the best employees need to be managed: trained, supervised, evaluated, monitored, directed, compensated, promoted, motivated, mentored and, often, befriended. They're going to have personal issues that someone is going to have to deal with. They're going to create office issues that someone is going to have to deal with. They're going to have employee/employer issues that will need to be dealt with. If all this sounds like it takes a lot of time, that's because it does. (In fact, most of my time is spent dealing with the employees of my advisor/clients because they don't have the time, or the expertise, to do it themselves.)

[Read about what happens when you pay too much.]

The bottom line is that when calculating the benefits of staff leverage, few advisors or their consultants factor in the additional time involved in managing those employees to determine how much time those employees really "save" an advisor. In larger advisory firms, with office managers, and often, human resources professionals, the time involved in "managing" each employee can be minimized, which can create greater potential leveraging. But in smaller practices, where any managing that gets done is performed by the one or two owner/advisors, tangible benefits of staff leveraging can be hard to create.

Picking the Wrong People, for the Wrong Reasons

It doesn't help that advisors, who generally don't have much hiring experience, tend to hire the wrong people, further decreasing the potential for true leveraging. All this isn't to say that advisors in small practices can't get the benefits of staff leveraging. They can, but only if they hire the right people, for the right jobs, and set up a management system to minimize the amount of the advisor's time that each employee will take.

Making the "people cost" problem even greater, many advisors tend to hire people for the wrong reasons. In addition to psychological reasons such as really enjoying mentoring or teaching, or larger firms making them feel more successful, independent advisors often try to solve the chaos that their firm has become by hiring more "help." This generally has about the same effect as throwing water on a grease fire: it only makes things worse. Without the structures in place to make every employee productive and successful, more "help" is only going to lead to more headaches.

So before you start spending your hard-earned revenues on more employees, take a step back. Employees are going to be your more expensive overhead item, and the most time consuming (yes, burning up even more of your time than technology, which is fast becoming the No. 2 time soak). Consequently, adding employees should be the last "solution" you should attempt, after you've explored and exhausted all other potential solutions to your current problems: better time management, real systems and procedures for all client services, better management of your current employees and a realistic business plan.

Once you have your current firm under better control, you'll also have a better idea of where you want to go, and exactly what type of employees (if any), and how many of them, you'll need to get there. With a plan like that, you'll be able to manage your employee costs much more effectively: both with the new folks you hire, and also with your existing employees--because you'll have a far better idea of how much they are worth to you, and how much they are worth in the job marketplace.

After all, in small businesses like independent advisory firms, the cost and management of employees are often the keys to the financial viability of the firm, and well as the happiness of the owner/advisor. The owner's happiness is, by the way, usually essential to the firm's success.

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