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.