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March 01, 2009 at 02:00 AM
I started my consulting career in 2001–not exactly what you would call optimum timing. The dot.com crash had taken trillions of dollars out of the economy and advisory practices were struggling with falling revenues from lower assets under management and the resulting higher workload from needier clients. Sound familiar?
Becoming a consultant during those difficult times was actually a tremendous blessing. Not only did many practices need help, but I got a bird’s eye view of what makes some practices succeed and others struggle, at a time when those differences were of utmost importance. Consequently, my goal has always been to help independent advisors build recession-proof practices.
These days, it seems everyone is asking me: Why do advisory practices fail? From my perspective the answer seems quite simple. For reasons that can only be explained to my mind as one facet of human beings’ seemingly infinite capacity for denial, advisors–like the rest of the financial services industry and the investing public–tend to believe that when the economy is good and markets are going up, they will always continue to do so. Instead, not only do they refuse to position their firms for times that might not be so good, they seem to go out of their way to overexpose and overextend their practices so that the slightest downturn becomes a challenge and times such as we’re having now become catastrophic.
Let’s have a little historical reality check, here. Now, this is a little before my time, but I’ve read that the financial planning movement was born in the late 1960′s when the “go-go” stock market up and went and formerly high-flying mutual fund sales folks started looking for a better way to help their clients–and make a living. Since then we saw another recession in 1979, a market crash in ’87, the mini-recession of ’91-’92, the dot.com crash of 2001, and the Credit Crisis of 2008. That’s six severe down markets in the past 40 year-history of financial planning, or roughly one every seven years or so.
That means the economy and the financial markets are going up about 85% of the time and steeply down about 15% of the time. It also means that during the good times, (which if ’81 to ’87, ’88 to ’91, ’92 to 2000, and ’01 to ’08 are any indication, are great for the business of independent advice) the question is not “if” the markets will eventually tumble, only “when?”
I’m as Clueless As You
So how can rational financial advisors, who assess their clients’ tolerance to the risk of market downturns and create diversified portfolios to protect assets against market downturns, consistently fail to plan for those same market downturns when managing their own practices? Don’t look at me: I’m as clueless about this one as you probably are.
Yet, rather than assume that every seven years or so, the markets will tank like the Chicago Cubs in September, advisors happily hire employees, move to fancier offices, add partners, buy technology, discount their fees, and anticipate selling their practices, all seemingly based on projections using their then current well-into-double-digit growth rates. What’s more, because those “never-ending” good times are so good in the advisory business, advisors who are suddenly making way more money than they ever expected to make don’t concern themselves with growing expenses, anemic profit margins, haphazard operations, underperforming employees, low staff moral, high employee turnover, lack of financial controls, vastly underutilized technology, uneven client service, or over-priced custodians or B/Ds. If they run into a problem, they can always solve it by hiring some more folks. And good luck to any consultant who tries to tell them otherwise.
When the markets inevitably went south, and fee revenues fell, many of these practices were in for hard times. As I’ve written before, unlike most industries, when advisory revenues fall, the workload actually increases due to the need for more (not less) client hand-holding. Without the revenue growth to hire more help, inefficient, low-margins firms find themselves in a real pickle during down markets.
