Is your firm ready to withstand the inevitable downturn (because you know it's coming eventually)?

On Sept. 22, 2014, the S&P 500 reached 1,994. That represented an 894-point gain (81.5%) from its 1,099 low on Nov. 10, 2009. Of course the market hit some bumps along the way, particularly in the summer of 2011 when it dropped 245 points to 1,099 again, giving back all its hard-earned gains to that point. Still, it’s had a pretty good five-year ride.

Advisors who had been riding substantially increased revenues on their assets under management during this recovery got another wake-up call in October when the S&P dropped 117 points (5.9%) from its September high. The stock market is historically cyclical, and the longer it goes up, the greater the likelihood that soon it will make a major correction.

Since I became a business consultant for independent advisory firms 14 years ago, I’ve witnessed two major market downturns: the dot-com crash of 2001 and the mortgage meltdown of 2008. Some of my advisor clients can add the recession of 1991 and even Black Monday in October 1987 to their list of bad experiences. During my two market drops, I noticed a surprising trend (to me, anyway), which also has been confirmed by advisors who lived through the other two “corrections”—advisory firm owners tend to do with their businesses exactly what they try to prevent their clients from doing with their portfolios: “buy high” and “sell low.”

That is, during market run ups, many advisors tend to run their firms as if the market will continue to rise forever. They stay in pedal-to-the-metal “growth mode,” adding clients, staff and overhead. Then, when the markets take their inevitable downturn—and AUM revenues drop—many of those firms struggle to keep their doors open until the market recovers sufficiently to bail them out. Not only is this uncomfortable for firm owners and their employees, it also leaves their firms in no position to take advantage of the very best time (by far) to attract new advisory clients: during the aftermath of a market crash and the early stages of the following recovery.

It doesn’t have to be this way. Based on our experiences (and no small amount of common sense), we have developed strategies that firms can implement when markets have been going up for some years (like now), which will both dampen the disastrous effects of a market drop and position them to take advantage of the eventual recovery. It’s like buying and selling stocks. The key is to invest for growth when the cost is low.

We’ve found that during extended periods of good economic times, firm owners should start “cocooning”: pulling in their businesses, building up their reserves and capacity, and stockpiling their resources to be ready when it’s time to spread their wings again.

When should advisors shift out of growth mode? As we all know, calling market turns is tricky (and if I could do it, I probably wouldn’t be writing this article). Most advisors’ experience tells them that the downside of calling the market too late and getting caught in growth mode (again) is so traumatic that giving up a little growth to avoid it is a small price to pay. So “now” is probably a good time to start (and would have been a year ago, too). Here’s what our client firms have been doing to prepare for a hit to revenues and position themselves to take advantage of the coming recovery.

Do shift focus away from growth and onto the bottom line through cash flow and profitability. A market downturn is going to reduce your revenues. Your first goal should be to minimize the impact that lower revenues will have on your firm. Now is the time to be building up your reserves, not spending money on bringing in new business.

Don’t continue to add a lot of clients. New clients take resources to attract, onboard and service. Now is not the time to tax your current staff or diminish your current work capacity. You want your firm positioned to handle some additional stress, not already stressed out. In most cases, the additional revenues from new clients will be far outweighed by the damage a downturn will do to an unprepared firm.

Do improve client service. Not losing existing clients in the downturn is Job One. It’s way cheaper, easier and more efficient to keep existing clients than to attract and sign up new ones. Now is the time to strengthen client relationships so they’ll feel more confident riding out a market drop. Effective strategies range from delivering great client service through every employee to preparing clients for a market correction in person and in other communications. The more your clients can get comfortable with their investment strategy, the risk level they are taking and their advisor’s actions to stay on top of the situation, the more likely they will be able to “stay the course” and ride out the correction.

Don’t add staff. In a market downturn, cash flow is going to be your biggest problem, and employees are usually the biggest expense item on most firms’ P&Ls. Not only do owner-advisors not want to have to lay off employees that they recently hired, new employees usually take time, and training, to get up to speed enough to make an impact—not to mention the additional time existing employees and owners will spend helping them get there. This is exactly the wrong time for that. In fact, now’s probably a very good time to re-evaluate any staffers you’ve been giving a “chance to come around.” It’s better for the employee in question, and for the morale of the other employees, to let them go in an up market, rather than after the market and the economy turns.

Don’t spend money. Actually, it would be better to say: Spend more carefully. The goal is to create a “war chest” of resources to be used when it’s time to go back into growth mode, and sometimes that’s best accomplished by investing in overhead-reducing strategies. The point is to use the resources you have to best position your firm to weather the coming storm and to take advantage of the opportunities when it’s over. It’s definitely not the time to be making over your office or moving into more expense digs.

Do find more efficient ways to operate. Increasing efficiency is the key to keeping down overhead. This is a good time to evaluate how your firm operates with an eye to finding better ways to organize, utilize and support your employees. Adding or improving technology and increased training are common tools to make employees more productive and successful. So are revenue-based bonuses that allow employees to share in their firm’s success.

Do add a marketing system. Most firms don’t have much of a marketing plan, let alone what might be called a “marketing system.” For firms that want to continue growing in today’s competitive advisory world, marketing has become a necessity rather than an option, but good marketing doesn’t happen overnight. Like building an advisory business, marketing is a process that takes time, planning and successful implementation. After a stock market recovery has started is the wrong time to start a marketing program. You’ll be way behind the firms that started before the downturn and that are already attracting new clients. Marketing isn’t free, but it doesn’t have to be onerously expensive, especially if you make a commitment and give your plan time to work.

Do have a plan for the recovery. The key to successfully growing an advisory business is knowing how much growth your firm can handle. By determining ahead of time how many new clients and assets are optimal for your firm, you’ll know when it’s time to shift out of growth mode and to start preparing for the downturn after the coming one.

The best time to grow advisory firms is in the early stages of a market recovery, when many clients are dissatisfied with their current advisors—and the more savvy investors recognize the buying opportunity. By positioning advisory firms for the worst during the up markets, they will have the resources not only to weather the down markets, but to take advantage of the next recovery to accelerate their growth. That way, they buy low and sell high.