The research is in and it turns out that it pays to listen to your clients. The results of the 2005 Rydex Advisor Benchmarking Survey reveal a strong correlation between the amount of time spent with clients and the profits the firm generates. Advisors who spend 60% of their time working directly with their clients are eight times more profitable than advisors who spend less than 30% of their time doing so (see Chart 1, below).

Yet, compared to 2003, the amount of time advisors spent working with clients and managing their portfolios decreased dramatically in 2004. RIAs in our sample reported spending only 19% of their time on client service, down from 36% in 2003 (Chart 2).

Clearly, advisors have been getting busier with tasks that are taking precedence over client contact. Our data shows that time spent on administrative functions nearly doubled from 11% in 2003 to 20% in 2004, while time spent on business strategy grew from 12% to 18%, putting both of these tasks on par with client service. Almost half, or 46%, of advisors felt that the “need to work on and in the business simultaneously” is the biggest threat to their business, second only to government overregulation, which was named by a whopping 65% of respondents (Chart 3).

Some advisors may be attempting to cope with the slippage in client contact. In 2004, the average RIA firm added one client-services staff member to its team. In the past year, client-servicing staff has increased to 43% of the average RIA firm’s headcount, from only 25% in 2003.

While running an advisory practice has gotten more complex, it has also grown more profitable. In 2004, advisors reached both their highest levels of assets under management (AUM) and profitability. Revenue grew by 18%, attaining the highest levels for at least the past six years, while principal compensation increased to 38% of total expenses, compared with 35% in 2003. After the sharp drop from 1999 through 2002, advisors saw AUM rebound in 2003 to $87 million on median at year end, then grow to a six-year high of $105 million on median at year-end 2004. The average account size grew 10% to $345,000.

Also in 2004, profits rose 24% to a median of $294,000, the highest in four years. While some advisors may think that increases in revenues are more important than improvements in margin, we disagree. Profit margin is a key indicator that revenue flows are reaching the bottom line, which in turn reflects the financial health of an advisor’s business. In 2003, profit margins fell though revenues rose. In 2004, revenues and profit margins improved–median profit margin rose 5% to 27.17% during 2004. In other words, for every dollar of revenue, advisors generated 27 cents of profit. Some of that increase may be attributable to M&A activity, as owners tend to rationalize their practices to prepare them for sale.

There are two ways to increase profits: consolidation and improving client service. The survey found that “positioning their practices for sale” is the most important goal for 30% of businesses (Chart 4). Our findings are supported by data from both a Business Transitions report that found an average of 30 buyers per seller, and the Schwab Advisor Transition Support service, which listed 85 firms for sale with more than $6 billion in total assets versus 250 buyer listings.

Consolidation is a hallmark of a maturing industry, and the advisory business is maturing–along with its participants. Just 13.4% of advisors have been in the industry less than five years, compared with 16% in 2003. Moreover, whereas the average age of advisors starting their own practices was between 40 and 45 years old during the 1990s’ bull market, in 2004, new entrants were more likely to be between 50 and 55 years old. Today, the majority of advisors fall within the 55- to 64-year-old age group.

In 2004, mid-sized firms–which typically experienced serious margin pressure–had 29 clients per employee with a median account size of $818,261 per client. Compare that to the larger practices (over $500 million) that had the same number of clients per employee, but a median account size of $2.08 million. The mid-sized firms appear to be in transition from a small to a larger model; they need more staff to improve client service, yet this has not yet resulted in increased profitability. Once firms reach the $200 million+ range, they manage expenses better and provide better customer service.

Attracting More Profitable Clients

The key to success today appears to be the ability to attract more profitable clients (Chart 5). In the 1990s, when client portfolios were climbing 12% to 15% a year, advisors didn’t have to add many new clients to achieve profit growth. That has changed dramatically. During the 2000-2002 bear market, firms of all sizes were awash with new prospective clients. But larger firms with greater staff support proved much more adept at replacing lower-asset clients with larger, more profitable ones. The average RIA’s high-net-worth clients now make up 61% of clientele compared to 48.7% in 2003. Ultimately, these clients generated higher profits, allowing larger firms to reinvest, add capacity, and continue to grow–that’s why the profitability gap between large and small- to mid-sized firms has widened.

In conclusion, the data suggests that for today’s advisors, time is money. Advisory firms are demonstrating their ability to weather the tough times of the last few years. But to continue their profitability in the future, they need to make client service a priority.