This is the final article in a three-part series on the challenges facing fee-only advisors, focusing this month on how advisors can use benchmarking tools to fine-tune their practices. Part 1, which appeared in the December 2003 issue, addressed advisors’ marketing challenges. Part 2, in the January 2004 issue, explored ways that advisors can use technology tools to increase their efficiency and competitiveness.
As with all small business owners, successful fee-only advisors ultimately reach a stage of development that calls for a greater focus on the business aspects of the practice. They need to know how well the practice is functioning, whether policies and strategies need improvement, and if the firm’s fees and expenses are appropriate. One way advisors can address these issues is to compare their practices against others in the industry.
While benchmarking in this fashion provides critical information, it can be a difficult task for independent fee-only financial advisors. By definition, they are sole practitioners, single-partner firms, or small partnerships. An unfortunate drawback inherent in this structure is a certain degree of professional isolation. The lack of a natural forum to interact with other advisors makes it difficult to identify benchmarks against which to measure the efficiency, profitability, or standards of an advisory practice.
Most advisors crave insight into what their competitors are doing and benefit from the ability to compare their practice with successful peers. The opportunity to measure oneself against others comes naturally to brokers and even financial planners who operate in a group environment. On the other hand, independent fee-only advisors must make a strategic decision to benchmark their practices. Once a practice has been in existence for three years or reaches a reasonable asset level, such as $25 million, it is probably time to make a concerted effort to benchmark.
Comprehensive benchmarking shows how one practice differs from the average advisory practice, as well as from above-average practices. Identifying these disparities does not necessarily mean the firm has to change anything, although it is likely to pinpoint some specific areas for improvement. It does enable the firm to take a critical look at the differences and determine whether each one is an asset or a liability.
For many advisors, the issue is not whether to compare their practices to an industry standard, but how. Their infrequent interaction with colleagues makes informal benchmarking virtually impossible. However, several benchmarking tools are readily available. The Financial Planning Association’s annual FPA Compensation & Staffing Study, for example, provides comprehensive data on compensation, staffing, and financial performance of financial planning practices. Charles Schwab and several other financial services firms also provide comparative data to their affiliated advisors. Benchmarking tools have been popping up online as well. Tiburon Strategic Advisors, where co-author Chip Roame is managing principal, has established a series of Web sites that allow all types of financial advisors to submit information about their own firm and in return receive compiled information on almost 4,000 other advisors. This tool for fee-only advisors can be found at www.FABestPractices.com. (AdvisorBenchmarking.com, an affiliate of Rydex Global Advisors that supplies Investment Advisor with content for its monthly Practice Edge electronic newsletter, offers a separate online benchmarking tool.)
Tiburon’s FABestPractices.com database is free to financial advisors and updated periodically. Its data can be sorted by the size of the advisory firm or by custodian. This allows advisors to compare their own practices to similar or larger ones. It also allows them to analyze the results of advisors using a particular custodian. We will present key averages from the data within this article.
We recommend two methods for advisors to effectively use the benchmarking Web site, depending on the advisor’s individual objectives. On the FABestPractices Web site there are 35 questions, with approximately 400 charts. The first method is to answer all 35 questions without spending time reviewing the related charts. This takes about 45 minutes. At the end, the advisor can print a free copy of a research report detailing the data Tiburon has collected from the site. When advisors are ready to take a step back and look at the practice as a whole, they can complete the entire survey.
Alternatively, they can use the second method if they need insight into a specific aspect of the business. They should review the list of questions and go directly to the question or questions that impact current decision-making. After answering those questions, they can review and/or print the related graphs. Some sample questions that begin the process are these:
o What year did you start or join your current business?
o Which licenses or designations do you hold?
o What are the primary sources of new money your clients invest with you?
o What are your primary sources for attracting new clients?
o What asset allocation software do you use?
o What were your client assets at year-end 2003?
o What were your revenues for the full-year 2003?
Benchmarks for Financial Performance
Although it can be useful to compare any aspect of a practice to an appropriate benchmark, the most commonly used benchmarks relate to financial performance. Five areas can be evaluated:
o Firm Profile
o Income Statement Averages
o Client Profitability
o Partner Profitability
o Employee Productivity
Tables 1 through 5 enumerate the results for each of these areas, based on Tiburon research.
The tables describe the average advisor in the survey, and it should be noted that the survey has attracted a group of very large, successful advisors.
Each table also provides space for advisors to list the statistics of their own practice for comparison purposes.
Several of the figures are worth examining more closely. In Table 2 (“Income Statement Averages”), the return on assets for an advisory practice is the ratio of its revenue to the assets it manages. In layman’s terms, this would be the average fee; it generally ranges from 65 to 100 basis points. Another important number in this table is the profit margin, determined by dividing total pretax profits by total revenues. The profit margin can indicate whether expenses are out of line with revenues. According to Tiburon research, this number ranges from 30% to 60%.
One set of benchmarks that can be extremely valuable in evaluating and improving the functionality of a practice are those related to client profitability. The series in Table 3 identifies exactly how profitable the average client is. It includes assets per client, revenues per client, and profits per client. If these statistics fall far short of the average advisory firm, a practice may want to take a harder look at individual clients to determine which ones are profitable and which are not. Focusing a practice on profitable individuals or profitable categories of clients can improve overall profitability.