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Practice Management > Building Your Business

Reality Check

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As financial advisors, you’ve undoubtedly found that a healthy skepticism is essential. You may have heard me say this before, but I truly believe that the role of advisors is to protect their clients from the financial services industry. Not that everything that comes out of Wall Street is wrong–only about half. Your job is to determine which half, and use that knowledge to your clients’ benefit.

Unfortunately, after long observation, I’ve found that financial advisors tend to be just about as human as the rest of us. That means, among other things, that about half of what you know to be true really isn’t. So I think it’s a good exercise to periodically examine the things we “know to be true” and explore why we think so. Here’s a list of possible misconceptions that I’ve found advisors to hold from time to time.

Misconception #1: Client portfolios need international exposure.

It’s true: investing overseas is hot–again. Again, because some of us are old enough to remember the last time “global” investing was all the rage in the early ’90s.

What did we learn in that experience that might benefit clients today? First, the risks are still higher overseas. It may be a global economy, but it’s not yet a global community. There’s political risk and currency fluctuations. Then there’s regulation, enforcement, accounting, reporting, etc.

The real problem is that most foreign economies are relatively small, which means they are easily affected by flows of investment capital. When institutional investors decide a certain country or region is “hot,” money floods in, boosting economies and stock prices. But, that money can cool, too, quickly moving on to another hot spot, leaving those economies and the investors still in them to crash and burn.

That’s not to say global investing is a bad idea–if you do it the right way. Smaller investors can get all the international exposure they could want by owning large multinational firms. Many big American companies (including financial services firms) derive a substantial portion of their revenues and profits from worldwide operations. And because they’re looking for business opportunities rather than investment opportunities, they tend to do their homework and take a long-term view. For even more international flavor, you could pick one of the non-U.S. multinationals.

Misconception #2: It doesn’t matter what other advisors do.

One of the indications that financial advice hasn’t quite emerged as a true profession is the trend among professional advisors to ignore what other advisors are doing. Their thinking seems to be that if they act professionally, with their clients’ best interests at heart, everything will be fine. Unfortunately, life is rarely that simple.

We all know that federal reforms can move glacially, but there does seem to be momentum building for a radical reorganization of the regulation of personal financial services.

Whether that happens sooner or later is anybody’s guess, but when it does, it’s likely to be a sweeping overhaul. It will be a minor miracle if financial planners avoid being categorized as either stockbrokers, insurance salespeople, or investment managers (and subject to their new respective regulators).

The problem for all independent advisors is how this group of financial planners will come to be perceived. Will it be as client-centered professionals with a fiduciary duty, or as the final link in the distribution chain for financial products and services? These perceptions are being formed as we speak, and the independent advisory community as a whole has yet to clearly demonstrate just which side it’s on.

Misconception #3: Your practice is worth more to institutions.

That advisory practices have a market value has become a widely accepted fact. We all know there are three ways to realize that value: sell to another advisor, sell to your junior partners, or sell to an institution. To date, the internal succession option, which is the preference of most advisors, has typically resulted in a far lower value devolving to the owner. I don’t believe that has to be the case, but that’s a discussion for another time.

That leaves institutional buyers and other advisors. While advisors pay around two times annual revenues over four years for a fee practice, institutions have reportedly paid much more than that. But before you start dusting off the For Sale sign and looking for an investment banker, you might want to consider why institutions are willing to pay more than advisors.

The independent market for advisory practices has reached a critical mass where it’s become efficient: the value of similar practices under similar deal terms is very consistent. Some folks believe the market overvalues or undervalues practices, but it seems to me that the best judges of value are working advisors who intend to run the practices they buy.

Why would institutions put a higher value on these practices? As far as I can tell, it’s a combination of three strategies: to market proprietary product, to market proprietary services, or to operate as a loss leader to sell more of the first two.

Advisors who sell out to institutions usually end up working for them, typically for at least five years. My sense is that if independent advisors really wanted to work for banks, they would already do so. Psychologically, it isn’t often a very good fit. Even without proprietary marketing pressures, it’s very hard for bankers to allow an entity they own to operate independently, outside of all those rules that make banks so much fun. And then, when they find they aren’t getting the return they expected from the inflated price they paid, things can get really ugly very fast. You have to ask yourself, is it really worth it, for you and your clients?

Misconception #4: Dealing with professional employees is a zero sum game.

I suspect this thinking comes directly from the way accountants approach business: they manage costs rather than make investments. So they naturally see employees as costs to be contained, rather than investments to be maximized.

All employees are investments, and professional employees are probably the biggest investment an advisor will make. But all too often, advisors focus on the “cost” of these junior planners, trying to pay them as little as possible. What kind of message does that send to the employee? It’s like buying the cheapest house you can find, and then being baffled that renters won’t pay much to live there.

The reason advisory firms hire junior professionals is to grow the firm’s business. That doesn’t mean new planners have to bring in clients: if they take work off the desk of rainmakers, who can then bring in more business, they’ve contributed to that growth. The question isn’t how little can you pay them to do this, but rather it’s what work environment–including compensation–can you create to maximize a young professional’s contribution to the firm?

I’m not talking about throwing money at people. It’s important to accurately measure the return on your investment in each professional employee–their contribution to the growth of your firm. Then, fairly structure their compensation to reflect that contribution. Consider including equity in that package: being an owner, even a minority one, is the best motivator of all.

Misconception #5: You need to use a custodian or a B/D.

Okay, so you probably still do need a custodian or broker/dealer. But the time is coming, probably more quickly than you think, when you won’t. If you can’t get software/online systems that do the clearing and custody as well as your current firm yet, you will be able to do so soon.

Then there’s compliance. There are systems available today that will store your scanned documents, monitor your investment policy statements, flag reviews, and save correspondence and e-mails–all to be downloaded onto a CD and presented to your auditor. Through technology, compliance will quickly become a worry of the past.

What’s left for custodians and B/Ds to offer? Information: practice management, best practices, new products, and the opportunity to compare notes about these things with your peers at regular gatherings. Don’t get me wrong: I don’t mean to play down the value of good information. But you do have to ask yourself: What’s the best way to get that info? From whom do you want to get it? What’s the best way to pay for it? The custodians and B/Ds of the future will have to offer good answers to each of these questions.

Bob Clark, a former editor-in-chief of this magazine, sagely surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at [email protected].


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