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This is the third of four articles, with an accompanying blog at, describing the Road to Independence that will be traveled this year by advisor Mike Patton. This month, Mike describes how his practice is showing signs of blooming.

As I sit to write these words I have reached the end of my fourth month of independence. It took a long time to make the decision to leave behind my corporate security blanket, but in retrospect, I’m glad I did. In this, the third in a series of four articles on going independent, I will attempt to spell out with some clarity what my business looks like at the moment and where I see it going. We’ll recap a few motivating factors of my decision and look at some of the processes and tools I use in areas such as portfolio management, financial planning, and practice management. In essence, we’ll peak behind the curtain of my company with the hope that you, the reader, will glean something of value. The new growth of my independent practice is beginning to take shape–and I like what I see.

The Exit

In my pre-independence days my time was not my own, and rightly so since my employer paid my salary. But security often has its price. My ability to perform in a manner which met my own standards was often impeded by decisions management made. I’m sure the firm did what it believed was best, but even the best of intentions don’t guarantee the best results. Efficiency experts point out that when decisions are made by those far removed from the point of impact, there is a higher likelihood that the results will be less than desirable. This assumes, of course, that there was little or no input from those close to the situation.

There is also a culture of politics prevalent in many large corporations. Middle management may be hesitant to rock the boat and this can suppress good ideas from being considered. It’s not the fault of any particular individual, but rather an evolution which has occurred over a long period of time in the business world, and particularly in the big financial services companies. In large corporations, what began as a focus on serving the customer’s needs has to some degree disintegrated into a need to hit revenue targets. Don’t misunderstand what I’m trying to say here. I’m acutely aware that revenue generation is crucial. It’s the method by which it’s accomplished that I question. When this “method” places the company’s or the individual advisor’s interests ahead of the clients’, it’s time to turn out the lights and go home, or should I say turn on the lights and provide full disclosure. In any event, the time finally arrived when my frustration peaked and I knew it was time to go. Some of you might have felt the same way and gone independent yourself, and others of you may be experiencing something similar as you read this. If so, I hope my experience is helpful.

The Process

In describing what I do in my new practice, let’s begin with financial planning. The phrase “financial planning” conjures up many definitions, not only in the minds of clients but in advisors’ heads as well. I would classify it this way. First, there are calculations or projections which might be referred to as modular planning. These may include such things as projecting the cost of college or a simple retirement plan. Then there are the comprehensive plans which involve a rather detailed process. The majority of the planning I do is in the latter category, involves several meetings, and typically takes 45-60 days to complete.

When meeting with a prospective client for the first time, assuming they are interested in engaging me, I will quote a minimum and maximum fee. This fee is based on an hourly rate multiplied by the assumed number of hours it should take to provide this service. The minimum fee is collected prior to beginning the work and the additional fee is paid after the plan is presented. For any subsequent work performed during the year, the client will receive an invoice quarterly. I should note they are free to implement the recommendations–investment or otherwise–with me or with anyone else they choose.

I love doing financial planning, but for many in our industry, a financial plan is merely a means to sell a product. On many occasions I’ve heard clients say something like, “We had a plan completed by XYZ firm and it seemed like all they wanted to do was sell us something.” Do we really think clients are that naive?

It has been my experience that most large financial services companies emphasize modular planning. The reason is very simple. A modular plan can be produced quickly and, because the company’s real focus is to sell a product or service, it doesn’t take as long to get to the point of sale. However, in the interest of the client, making decisions without a comprehensive analysis can often lead to inferior results.

My personal philosophy is this. Become thoroughly familiar with the clients’ situation and circumstances before rendering advice.

I think it’s also important to let clients know what is expected of them and what they in turn can expect to receive from me.

The Tools

Now let’s talk about the tools of our trade. I’ve tried many different financial planning solutions over the years, including Financial Profiles, Naviplan, SunGard, Wealth Tec, and CCH. Most of them were good at certain things and weak on others. Since none of them completely satisfied my needs, I ended up writing my own using Microsoft Excel. I added to this a very robust package which includes Monte Carlo simulation and optimization.

Now let’s turn the discussion to the financial planning tool’s output. First, it’s extremely important to answer clients’ immediate questions. Beyond this, I will answer questions they haven’t even asked, but yet are important. Some of the specifics include analyzing the probability of their running out of money at various ages or the probability that their estate will exceed the federal estate applicable exclusion in 2008-09. I will also analyze the probability that their current portfolio will experience negative returns over a one-, five-, and 10-year period. Using their total portfolio or a specific account, I can demonstrate the range of returns within a certain probability. If they would like to preserve a certain amount of their assets for their heirs, I will provide them with the probability of achieving this. In short, there is really no limit to what can be analyzed. (For a description of just such an analysis–on an insurance policy–see the sidebar “A Case Study“.)

Planning to me is really a way of answering questions. Comprehensive planning brings the client’s entire situation into focus, resulting in better decisions. When this is cheapened by those who purport to be planners but are really just salesmen, it hurts the entire industry. There is a silver lining here. The existence of this “sales” approach provides me with a competitive advantage. You see, it’s easy to make a clear distinction between that and what I’m doing.

Portfolio Management

Let’s move on to portfolio management. There are many different ways to create and manage a portfolio. Some practitioners believe in a passive strategy, others prefer an active approach, and the rest fall somewhere in between. I believe both passive and active have merit. If I use a passive strategy, I’m more inclined to use it in the large-cap stock area since it’s a more efficient market than small caps or emerging foreign stocks. Obviously, portfolio management is an art as well as a science. Here’s how I do it.

First, I will determine the client’s approximate required rate of return (ROR). This is usually derived from their financial plan. Once I know this, I look to my nine model portfolios to see which portfolio has an expected return (ER) close to the client’s ROR. In calculating expected return, I use a weighted average where stocks are assigned a return of 10%, bonds 5% to 6% depending on their tax status, cash is at 3.5%, and alternative assets vary depending on the type.

Then I’ll look at the risk of the portfolio as measured by the standard deviation, and compare it to the client’s risk tolerance as measured by a questionnaire I use. If their tolerance for risk varies greatly from the risk of the model portfolio, further discussion is needed.

When I created my model portfolios, I began by selecting broad asset classes. I use four: stocks, bonds, cash, and alternative investments. Within the stock category I use: large value; large growth; mid cap; small value; small growth; large foreign; and diversified emerging markets. Generally I favor value over growth and large cap over small cap. With bonds I use: ultra short term; short term corporate; short term government; mortgage backed; intermediate term corporate; and inflation protected securities. The alternative category includes real estate; market neutral vehicles; hedge funds; and structured equity.

With bonds, I have three primary sub categories. They are intermediate term corporate, inflation protected securities, and mortgage-backed. Generally speaking, assuming they are option free, intermediate term corporate bonds do well when interest rates are declining, mortgage-backed securities favor a more stable interest rate environment, and inflation protected securities should hold up better when rates are rising.

The objective is to create a positive return from the bonds regardless of interest rate movements and should be achievable unless rates are increasing at a rapid pace and in large chunks. However, if rates are rising, it’s possible that the Fed is raising them to suppress inflation. If inflation is threatening, it’s likely that the velocity of money is increasing as demand outstrips supply. If the velocity of money is increasing, then it’s very possible corporate revenue is rising and presuming those corporation aren’t spending foolishly, their profits are improving. If their profits are improving then I would assume, in the absence of scandals, terrorist attacks, or other anomalies, that the stock market is improving.

I’m also looking for managers who have low expenses and have consistently outperformed their peer group; I use a market filter on a daily basis to monitor this comparison.

I’ve adopted a strategic asset allocation policy but will make tactical moves at times. For example, when rates were at historic lows I increased short- and ultra-short-term bonds as well as inflation protected securities. To assist, I subscribe to Morningstar Advisor Workstation which gives me access to all mutual funds, stocks, closed end funds, variable annuities, ETF’s, and hundreds of indexes. With this tool I can track client portfolios, monitor changes, and conduct research as needed.

Before adding a holding to an existing portfolio, it must be determined that it will enhance the diversification of the portfolio by either increasing the return or decreasing the risk. The correlation matrix is essential here.

Practice Management

Efficiency in execution is vital. As an independent, there’s never enough time in a day to accomplish everything you want to do. Having the right tools can provide the leverage necessary to carry out the plan. The first piece of the puzzle to me was a good contact management system. I’ve chosen ACT basic and have customized it by adding tabs and fields to reflect my business needs.

There are many more things we could discuss but they’ll have to wait for the next installment which will as of now is scheduled to run in the November issue. Until then, please feel free to visit my blog at and post your comments and questions there or send an e-mail.