If there’s one piece of investment advice that’s almost universally agreed upon by financial planners, it’s this one: don’t bail out of stocks after a bear market. In fact, the entire foundation of wealth accumulation in the financial planning world is predicated on a healthy exposure to stocks for the long run, especially during the accumulation phase.
The planning world has attached itself to this stocks-for-the-long-run focus over the past two decades with its shift to an assets-under-management (AUM) business model, where revenues and value for the firm are tied to the markets in a similar manner to the client’s wealth and (future) income.
Yet in recent years – and especially since the 2008-2009 bear market – some planning firms have been starting to shift away from the AUM model, opting instead for more stable income business models like retainers. Yet this raises the question: if clients are supposed to stick with stocks for the long run and stay the course through temporary market downturns, are planners being hypocritical by not doing the same thing with their AUM business model?
An Advisory Firm As A Stock Versus A Bond
The inspiration for today’s blog post comes from several conversations I had last week at the FPA Retreat conference in Bonita Springs, Florida, with planners who shared that over the past two years, they have been shifting their practices away from an assets-under-management business model.
Their concern, as highlighted above, stemmed from the 2008-2009 bear market, which ravaged the profitability of the firm for a year as the markets fell. With even balanced portfolios dropping by upwards of 20%, the bear market took a 20% slice out of the firm’s revenues (even assuming there was no client attrition during the turmoil). The stress to the owners of many planning firms was substantial, and simply put is not something they wish to repeat. So they have spent the past two years converting their business model to one that will generate a more stable income stream – e.g., via retainer fees rather than billing based on assets under management – so they will not be exposed to so market volatility.
Yet in hearing the discussion, I was struck that in essence, the firm owners were saying that they didn’t want to stick with the ups and downs of stocks anymore; that instead, they’d rather their practice generate steady income with regular retainer fees rather than billing on a market-volatile asset base. In other words, after the bear market, they had decided to turn their financial planning firm into a bond (steady income payments, little fluctuation of principal), rather than a stock (short-term volatility, long-term growth).
Now I will grant that there are some who have very negative overall perspectives about the stock market these days, and if you really believe that the stock market is “broken”, then I understand the decision to unhitch your financial planning practice from that wagon. But these financial planners don’t think the stock market is broken. They’re still directing their clients to stick with stocks for the long run, to stay the course through the market volatility of the recent years and over the past decade. In other words, it sounds a lot like they’re telling their clients to stick with stocks for the long run, even while they convert their own financial advisory to one that bails out of stocks in favor of a bond-like business model.
To be fair, it’s worth noting that the financial implications of market volatility for a financial planning practice under an AUM model can be somewhat more severe than for an individual client, because of the nature of business operational leverage. For a client, a 20% decline in the portfolio means a 20% decline in value. For a planning firm that might have 75% of its revenue tied up in direct and overhead costs with a 25% profit margin, a 20% decline in revenue can result in an 80% crash in profits (e.g., firm revenues $1,000,000, direct and overhead costs of $750,000, profits of $250,000; if the market and revenues decline 20% to $800,000, the firm’s profits drop from $250,000 to only $50,000). So yes, we are talking about a somewhat riskier investment here. On the other hand, the planning firm can make up portfolio declines with new clients coming into the firm (comparable to clients who continue to save and make contributions to the portfolio). And the reality is that business ownership entails some risks; that’s just part of the deal. Presumably, if firm owners weren’t comfortable with business risk, they wouldn’t have gone down the business ownership path in the first place?
So the contrast still remains. If we financial planners all truly believe in stocks for the long run, and continue to tell clients to sit tight in the markets with a long-term time horizon and stay the course, then why aren’t we comfortable taking our own advice when it comes to anchoring our business model to AUM? Why can’t we view stocks as being volatile in the short-run but superior growth in the long-run for our firms, the way we tell the story to our clients for their portfolios, and stick with a stock-like AUM fee model over a bond-like retainer fee? Why are many planners converting their practices from growing like a stock, to functioning like a fixed-income bond portfolio? If we tell clients that bond-heavy portfolios are too unproductive for the long term, failing to provide an effective growth rate in excess of inflation, then are many planning firms leaving the AUM model going to cause similar long-term damage to the growth of their own firms and business value?
So what do you think? Are planners being hypocrites about their own advice, bailing out of the markets while clients are encouraged to stay the course and keep invested in equities?