A lot has been written about practice management in the investment advisory space. Many of the articles offer dark implications that somehow advisors are genetically endowed with poor business skills. The underlying assumption is that running an investment advisory business is just like, well, running any other business. You hire and manage people, you collect revenues from your clients, you create internal systems and procedures, buy software and IT services and market yourself to the community.
Just like everybody else, right?
In fact, the business dynamics that an advisory firm faces are so fundamentally different from a normal enterprise in the U.S. economy that any normal small business owner, dropped into your executive chair, would feel like she had been transported to another planet. The laws of business physics are different, the nature of the competition is different, the normal marketing principles don’t apply to you, and the advice you provide runs counter to every instinct of your paying customers.
To see how exceptional your business climate really is, let’s take a quick tour of some of the differences between an investment advisory firm and a normal member of the business landscape.
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1. Your clients actually pay you less during those times when they need you the most.
In any normal business activity, more work is the consequence of more business and, therefore, more revenues. But think back to 2008, and you realize that your business, if you charge AUM fees, has it completely backwards.
When the markets tanked, AUM revenue tanked accordingly. Firms with a healthy 30% profit margin, whose aggregate client portfolios declined by 30%, suddenly found themselves living on a pay-as-you-go basis. Meanwhile, your docile herd of clients was stampeding in all directions. Instead of one or two phone calls a day, the phones rang all day long, as clients clamored for reassurance. You had to talk them out of making important financial decisions in a state of panic, keep them abreast of what was going on in markets you didn’t understand yourself, re-run their financial projections every couple of months and help them figure out how to adjust future spending expectations. One-meeting-a-year clients became every-two-week phone calls, and your planning software looked like it was going to wear out.
Meanwhile, your staff was working overtime to keep the ship upright during a year when you probably weren’t able to afford to pay bonuses, when the profit sharing plan didn’t kick in because there are no profits. In any other firm, working overtime means that the firm will be paying out generous bonuses due to the increased revenues.
There’s a management lesson here that doesn’t apply to most companies: Advisory firms that rely on AUM revenue have to be unusually profitable during the good years (i.e. when markets are going up), in order to be able to weather the inevitable market downturns.
2. You charge the same commodity that you happen to be managing.
Getting paid for portfolio management and financial planning work, and charging for your money management, puts you in a unique and uncomfortable position that most businesses don’t face. You have near-total access to your clients’ financial situation. You know how much they can afford to pay you. And then you determine your fee.
In what other profession is there a temptation to discount fees because you know that what you charge will be a stretch – or because you know, from your routine professional evaluation, that your clients are experiencing cash flow stress? On the other end of the spectrum, you know when your clients can afford to pay a lot more than you’re currently charging. Either way, there’s a temptation to lower or raise your own compensation based on your professional activities and understanding.
There’s a practice management lesson here. Doctors don’t look at a client’s ability to pay when they assess their fees, and I don’t know any plumbers who check your portfolio before they decide how much it’s going to cost to fix your frozen pipes. Advisors have to be capable of setting appropriate fee schedules for the services they provide, and ignore the temptation to discount or raise the fees based on what they know about the client. I know some advisors who refuse to discuss fees with clients at all; that becomes the job of the office manager, who isn’t privy to the client’s financial situation and is therefore not tempted to make adjustments.
3. In the investment advisory business, good times lead to fewer marketing opportunities.
In a normal business, a booming economy and roaring stock market are the times when you want to double-down on your marketing efforts, add capacity and grab new customers with both arms.
But when the investment markets are going up, suddenly the clients stop calling. What’s the incentive to consult with a professional when all you see on your statement is positive numbers? You hear people say things like: “Anybody can make money in the stock market.” There’s no pain, no anxiety, and often not a noticeable difference in the returns that advisors achieve versus consumers. Unless they’re facing a life dilemma, there’s nothing in those happy market runs to drive people to your door.
That, of course, means you have to do your best marketing when times are really awful. When a downturn sucker-punches millions of self-confident investors, that’s when they’re most likely to call for help.
Of course, that’s precisely the time when you’re extremely busy servicing your existing clients. (See item 1.) It’s the worst possible time, from a client service and practice management standpoint, for new clients to knock on your door. Is there any other business or profession that you can say this about?
The business lesson here is that advisory firms need the same discipline in their marketing activities that they apply to rebalancing client portfolios. If marketing is a habit, and not something they do when they have free time, then advisors will be reaching out to consumers right when they most want to be helped.
4. Your core job is to select or demonstrate exceptional talent in a universe where it is nearly impossible to prove that exceptional talent actually exists.
If you or I were to join in on the National Football League’s annual scouting combine, the professional scouts would not have a problem deciding whether we were ideally suited to play offensive tackle or wide receiver. The tackles are six and a half feet tall and weigh over 300 pounds of gnarly muscle, and the wide receivers race gazelles for fun. If you or I lined up across the net from a professional tennis player, the odds would clearly not be in our favor, and (this is the important point) pretty much any spectator would be able to see this at a glance.
But no such certainty exists in the investment space. A fund manager has a great year, blasting the benchmarks. Is it luck or skill? Who knows? An above-average 10-year track record does not, statistically speaking, prove anything, and at the end of 20 years, when the numbers are starting to become compelling, the manager is about to retire. Unlike tennis tournaments, where the top players usually finish at the top of the standings, the mutual fund rankings welcome a totally new face to the top every year.
The point here is that not even the angels themselves know luck from skill in the investment space. If your job is to select the best, most perceptive fund managers, you’re flying very nearly blind. And when your clients select you, they’re in even worse shape; how can they, with less training and experience, evaluate the relative performance of the custom portfolio you provide them? How can they tell whether you’re adding value or not? In what other field of endeavor is the quality of your work so well-hidden and difficult to prove?
The lesson here is obvious: even though your stock in trade is investment advice, you cannot base your value proposition on your investment returns. I doubt if professionals in any other field could say something similar.
5. Your best advice is usually 180 degrees different from what most people are thinking or planning to do.
The best investment advisors are like salmon swimming upstream against a very strong current, except that they never get to the spawning ground. Most individual investors believe that it’s possible to move into and out of the markets and avoid downturns. They think the fund that beat the market by 85 percentage points last year is a terrific place to put their money over the next 12 months. When the market is soaring, most people want to sell their fixed-income ballast and go all-in. When the market has tanked and stocks go on a fire sale, most people want to go to 100% cash and stuff the bills under their mattress for safekeeping.
Am I right? What other professionals have to constantly give their customers advice that is directly opposed to what their customers think and feel and believe, over and over and over again? Have you ever had a client walk in the door who believed in long-term investing no matter what the markets did, and who was suspicious of hot funds and immune to the herd instincts at the top and bottom of markets? Do doctors or lawyers have to deal with herd instincts and internal emotional compasses that constantly point in the wrong direction?
I would love to see how business owners in any other field would handle a stampeding herd of customers in a market downturn. This is not a subject you see covered in standard MBA courses. I’d like to see a Harvard case study that illustrates the proper technique for telling 20 clients a day that they may have to adjust their future spending needs, and that getting out of the market now will only make things worse.
The business lesson from this, which is probably unique to the investment advisory profession, is that your greatest value comes from convincing your clients to do things which are exactly the opposite of what they intended when they walked into your office. This is a skill that few business owners in any other field have to cultivate.
6. Your business is in active competition with the media.
Back in the 1990s, Money magazine declared itself to be “America’s Financial Planner.” Its writers openly and persistently questioned the need for its readers to seek help outside of the monthly publication whose cover would tout “the 10 best stocks to buy now.”
Meanwhile, the financial TV stations offer all kinds of investment advice, from the idiocy of Jim Cramer to the plausible-looking portfolio managers in dark suits who calmly predict the future (and are never held accountable for their predictive failures). In any other professional field, people who act like they can predict the future in granular detail would be hooted off the stage – or at least be required to wear a wizard’s hat and peer into a crystal ball. In the investment media, these predictions are a routine event.
Most advisors don’t stop and realize how unusual this is. Do people wonder whether they should get their medical advice from a TV show, a magazine or their doctor? When you get sued or file for divorce, do you turn to a screaming madman on TV to find out what to do next?
The business lesson is that you always have to be prepared to articulate your value proposition – that is, how clients’ lives will be better after working with you – and that proposition has to be more compelling than the various free alternatives. I’d love to see what the business textbooks have to say about that.
7. You also directly compete with robots.
Plumbers, doctors and lawyers don’t have to worry about the equivalent of robo-advisory firms telling people that algorithms are all they need in the way of professional advice. I understand the value of hands-on investment management and (for those of you who do it) financial planning services. But to the consuming public, those are ancillary (and may be viewed as unnecessary) services, rather than the core value proposition.
You also receive troublesome competition (unlike doctors, attorneys, plumbers and tax preparers) from peoples’ uncles, friends, in-laws, hair dressers and anybody else with strong opinions about the markets. This is not a marketing dilemma they teach about in the MBA programs. It is a unique management challenge that only investment advisors have to face.
In my recent webinar for APViewpoint, I offered a more detailed version of a very basic business lesson for advisors: Whatever the robo-competition commoditizes (in this case, automated rebalancing and tax-loss harvesting) needs to be outsourced, so you can spend more time in front of clients doing things that robots will never do effectively.
8. The most fundamental things you base your advice on change, on average, every two years.
I’m talking, of course, about the ever-evolving tax rates, for income, capital gains, estates, singles, couples, AMT... In passing, I should mention constant IRS fiddling around the margins, like determining how much of a discount you can take when passing minority interests of an asset to heirs, or whether you’re allowed to zero-out a GRAT.
Admittedly, there are new innovations in medical technology, and lawyers have to adjust to new precedents in case law. But what makes the situation for investment advisors unique is the fact that you give advice based on one set of rules, knowing in advance that the rules will change 20 times or more in the 40 years between today and when the client gasps her last breath. The advice you gave today may turn out to be at odds with some future quirk in the tax laws, and you have to constantly adjust the client’s plan to reflect the next reality. What other businesses have to revise or reissue their stock-in-trade constantly on an ongoing basis for their long-term customers?
The business lesson, if you can call it a lesson, is that advisors have to be exceptionally comfortable living with uncertainty and flux, at a level which is seldom demanded of other business owners.
9. Your regulatory structure treats you like a criminal.
Do psychologists or attorneys have to maintain anything close to the books and records that the SEC requires of you and periodically audits? (Why are those recordkeeping requirements even enforced, in a world where all the trading and account balances are transparently available through your custodial platform)? Is the CPA with a tax practice down the street required to have a thick operations manual and business-continuity plan? You are monitored by how much you charge clients regardless of what services you offer; does that happen to plumbers or doctors?
Of course, you can’t tell clients about your investment performance without going through a huge accounting hassle. Every other business entity in the free world can ask its customers to write testimonials about the quality of their products and services. If you do such a thing, it could land you in jail. God help you if you sell anything for a commission, because your Series 7 license comes with a stern prohibition against communicating openly with your clients until and unless your communications have been reviewed and emasculated by people with a sense of humor almost as keen as a robo-advisor’s. All of these are challenges that most business owners only dream about – in their worst nightmares.
I won’t even try to draw a business lesson from this. But I will say that if anybody tries to tell you that you aren’t a skilled business manager, invite them to live under your regulatory structure for a year or two. At the very least, that will shut them up.
10. Smaller firms are systematically taking market share away from the largest, most powerful competitors.
In just about every other industry and profession, the rich get richer. The firms that can buy Super Bowl advertising and have their logo on America’s tallest buildings gobble up or crush their smaller competitors as a matter of normal business routine.
But in the investment advisory space, the opposite dynamic has taken hold. As the smaller firms experience double-digit growth in assets and clients, Wall Street is experiencing a slow leak of market share to the many smaller investment advisory firms that have no advertising budget or tall buildings on which to put their logo. Extinction events are routine. At our upcoming Insider’s Forum conference, we’re going to be giving out T-shirts with little tombstones on them: Prudential Securities, 1879-2011; E.F. Hutton, 1904-1988; Dean Witter Reynolds, 1924-2009; Shearson, 1902-1994; Drexel Burnham Lambert, 1838-1990; Kidder Peabody, 1865-1994; Lehman Brothers, 1850-2008; Bear Stearns, 1923-2008; Salomon Brothers, 1910-2003. (The surviving firms will be illustrated as different species of dinosaur.)
This offers the overarching business lesson for investment advisory firms. The next time you read that your profession has severe, crippling management issues, look around at all the small businesses in other fields that are hanging on for dear life against their multinational competitors. Imagine what would happen if they, with their MBA and management training and business skills, were suddenly dropped into the strange dimension that you have to operate in, where none of the rules they teach in business school apply, where down is up and up is sideways and skill is impossible to identify much less prove as you fight off the media and the robo-competition and try to stay one step ahead of the hostile regulators.
The best business minds in the country would have a pretty hard time duplicating the success enjoyed by all the small advisors who built this profession up from nothing, who are destined to take their market away from some of the largest and most powerful corporations in the world. The practice management gurus remind us that you could probably do a better job of creating incentive bonus structures, software stacks or more efficient operational processes. There are probably a lot of HR functions that could be improved, and the lack of marketing acumen across the profession is certainly unusual.
But from where I stand, you’re doing a pretty good job at the important stuff. You’re thriving in the strangest, toughest corner of America’s business ecosystem.
Bob Veres’s Inside Information service is the best practice management, marketing and client resource for investment advisors and financial planners. To get a free sample issue of Inside Information, send your request to [email protected], or order online at http://www.bobveres.com.
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