"The most successful advisors don't take the conventional wisdom about building a practice at face value."

Taking Stock

By John Bowen

As you look ahead to 2004, now is an ideal time to take stock of the challenges you faced last year and begin to craft solutions to them. Because we work directly with some top advisors in the industry, we see how they devise effective responses to the challenges they face. Consider applying their lessons in your own practice.

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So what are the top three challenges advisors face in today's environment? They are the explosive growth of affluent investors, the proliferation of new competition, and a heightened focus on first-class customer service.

1. The explosive growth of affluent investors. Fueled by long-term equity growth, technology-driven business expansion, and the widespread practice of including stock options in compensation packages, the number of affluent Americans has skyrocketed.

Despite the just-ended three-year bear market, affluent clients still have tremendous capital to invest. According to the Merrill Lynch/Cap Gemini Ernst & Young World Wealth Report 2002, there are over 2.2 million people in North America with financial assets of at least $1 million, not including real estate. Three decades ago, there were only 90,000 people who had a net worth including their homes of $1 million.

There is a deepening pool of wealthy investors out there—so many, in fact, that you need only capture a tiny slice of market share to be successful. Unfortunately, most advisors haven't focused on one affluent target market so they can understand the unique needs and challenges their clients face and deliver a consistent service profitably.

2. The proliferation of competition. The growth of the affluent marketplace has hardly gone unnoticed. It has increasingly drawn the attention both of up-market participants moving down market and mass-market participants trying to move up market. The number of competitors has increased, as has the types of competitors out there.

Many professionals who haven't offered any investment services—accountants, insurance agents, and lawyers—are adding investment advice into their practices. At the same time, traditional transaction-oriented wirehouses like Merrill Lynch are aggressively promoting their own investment consulting. And Internet technologies have generated several new sources of investment advice.

With this proliferation, what were once valuable investment strategies have largely been reduced to commodities, easily dispensed by advisors with less knowledge and experience. This increased competition has diminished the ability of many truly independent investment advisors to differentiate themselves from competitors who offer a broad package of products.

3. A heightened focus on client service. Coping with the market's volatility over the past few years has been challenging for even the most experienced advisors. But if this has been a difficult time for you, just consider how your clients are feeling. Without your knowledge, experience, and perspective, it is even harder for them to hold steady during periods of intense volatility.

For this reason, it has never been more important to be in close communication with your clients and focused on providing the service and guidance to see them through these turbulent times. Unfortunately, most advisors are missing a big opportunity by being investment-centered rather than client-centered. They spend too much time trying to uncover the best investment solution rather than helping clients to achieve their financial goals.

These three challenges affect every advisor's business and will continue to do so in the near future, forcing you to react in some way. But if you want to be successful, you have to do more than simply react. You have to turn these challenges into opportunities to benefit both you and your clients.

Fortunately, the top advisors in our industry provide a wealth of clues about how they are turning challenges into opportunities. Following are three of the most important solutions that top advisors have formulated to meet the challenges they face. By studying and understanding these responses, you'll be poised to incorporate the best practices of these elite advisors into your own advisory business.

1. Reinvent the business model. The most successful advisors don't take the conventional wisdom about building a practice at face value. Instead, they carefully consider what works to increase their income and don't pursue avenues that don't lead to a higher net income.

These advisors question two closely related assumptions. The first is that the best way to be successful is to stay in business and work to build your book of business or managed assets and client base. However, CEG Worldwide's research shows that this conventional wisdom is the very formula for not making a good living. In fact, we have found little correlation between the number of years in business and income.

Many top advisors are now abandoning traditional business blueprints and drawing their own. These new models ignore conventional wisdom when it benefits both clients and the advisor and are flexible and nimble enough to capture opportunities in the current marketplace. More often than not, these opportunities lie in serving the affluent.

The second assumption elite advisors are questioning is that all growth in the business is good and will eventually lead to success. In the traditional business model, an advisor typically starts out as a sole practitioner and, as clients are added, hires staff and eventually brings in partners. As new clients come in, new staff is hired to service them. Higher revenues are the panacea.

But the assumption that economies of scale will result from higher levels of revenue and larger numbers of clients is untrue. As overhead increases along with revenue, there is no significant increase in margins. A study by CEG Worldwide shows practitioners with gross revenues of more than $1 million have pre-tax profit margins of 25.6 percent, while these margins top 40 percent for advisors who have gross revenues between $100,000 and $500,000.

Elite advisors realize gross revenue is fairly irrelevant. They understand that cash flows drive what's truly important—net income and firm valuation. A conviction that these two factors are the only truly meaningful indicators of success underpins their perspective and frees them to think about their businesses in new and innovative ways.

These advisors are redesigning their businesses from the ground up to take advantage of different kinds of opportunities—those derived from working with a select group of affluent clients. They are intensely focused on serving their existing clients well and are constantly on the lookout for innovative ways to improve their client service.

2. Serve fewer clients. Top advisors understand that to serve affluent clients well, they must have fewer clients. With fewer clients, they have the time they need to provide a consistent, high-quality experience, which will improve client retention and referrals. Through these strong, lasting relationships, top advisors build profitable practices.

In contrast, many less-successful advisors simply have too many of the wrong type of clients. They maintain clients who demand their time but who do not support a high level of success for their practices.

Many advisors may think that more clients mean more income. But another study by CEG Worldwide found that advisors in the higher income brackets actually have the smallest number of clients. In fact, the average number of clients for advisors earning between $150,000 and $1 million was just 172.

And the advisors in our study earning more than a million dollars per year, the best of the best, had an average of just 43 clients each. It's clear these advisors have structured their businesses so they can provide the type of service that their affluent clients demand.

3. Focus on clients, not investments. Advisors have to shift their focus from ubiquitous, commoditized investment management services and put it squarely on their clients. They must work to foster ongoing relationships and offer all of the services and products that are closely tied to client needs.

One of the few aspects of the advisory business that can never be turned into a commodity is the advisor-client relationship itself. Advisors must make it a top priority to enhance their client relationships. Investors can buy generic products anywhere. It is only by building the relationship and becoming a trusted advisor that financial advisors will succeed over time.

When one CEG Worldwide study asked advisors about the obstacles they face in expanding their business, more than 90 percent of the top advisors mentioned building their relationships with existing clients. In contrast, just under 40 percent of lower-income advisors believed it was a significant barrier.

I encourage you to examine these solutions in the context of your own practice. It all comes down to the fact that there is a huge need for advisors to redefine their business models to meet client needs. Fortunately, as the top advisors have shown us, today's challenges are rife with opportunities. You owe it to yourself and to your clients to uncover these opportunities today.