Staying Seaworthy: How Lifeboat Drills Help Prepare Clients for Market Downturns

Jul 29, 2014

If you have been reading this blog for any length of time, you know that I would not consider myself an investment guy. Sure, part of my job is to manage a team of professionals that ID-10018620analyze client portfolios. And sure, I can at least sound convincing when talking about the markets and investment products with most advisors and their clients — you do tend to pick up things in close to 30 years in our business. I personally believe that advisors can’t differentiate themselves by focusing on investments or the products that they sell. They can only set themselves apart with personal attention to their clients and the advice they give.

With that said, today I want to talk about investments and your business. While it might be tempting for both you and your clients to “set it and forget it” when the markets are up, history indicates this is exactly the wrong approach.

Complacency = threat

Last year, I heard a very interesting quote from Bob Veres at a conference I attended. Bob said that “complacency was the biggest threat to an advisor’s business.” I would like to add to that today, complacency is also a huge threat to an investor’s portfolio.

A quick look at Google Finance today shows the S&P up about 190% since March 9, 2009. Investors that rode out the financial crisis and recession of 2008 and 2009 have been rewarded for their trust in the markets (and in you) and are probably sitting on some pretty big gains in their taxable portfolios. Even in their qualified accounts, they only have to look at the 5-year return number to see some impressive results. It seems like almost every time I turn around, we hit another all-time high in the Dow or S&P and the performance numbers on client statements show it.

The advisory business is good, too. In their State of the Retail Wealth Management report, PriceMetrix showed that the average advisor’s AUM increased from $80.8MM in 2012 to over $90.2MM in 2013. Many advisors that I talk to say that while they are not adding a lot of new clients right now, they are “comfortable” with their businesses right now. But consider this: We have gone 33 months since the last 10%+ correction. That’s only happened four other times in history:

  • 2005-2007
  • 1984-1987
  • 1934-1937
  • 1926-1929

After each of these timeframes, the market had 35%+ corrections. My guess is that volatility was probably very low during the end of these five timeframes. Anyone take a look at the VIX lately? This doesn’t mean that I am making a call on the markets, and it doesn’t mean that I am bearish. In fact, I have always been a long term bull and still am. What it does mean is that I am realistic and want to be prepared for whatever happens and so should you (and your clients).

I don’t do investments, but I do offer advice

To me, there are two times an advisor really earns his/her advisory fees:

  1. In times of crisis, by holding the hands of clients keeping them assured, and, ultimately, in the markets
  2. Times like right now. We earn our fees by forcing clients to make decisions when they’re “fat and happy” or complacent, or at least prepare them for what lies ahead. Our job is to help them make the decisions that they won’t make by themselves, or at least to make them think about actions or inactions.

Lifeboat drills

Nick Murray (whom I have been reading for most of my career) calls them lifeboat drills. If you have ever taken a cruise you know that the first day, you are taught what to do and where to go in case of emergency. You line up in little groups near the lifeboats until crew can verify that everyone on the ship knows exactly what to do. The hope is that by training you (when you are sober), you won’t panic if something does happen. I think the same analogy applies to the inflight seatbelt announcements before every airplane takeoff.

When is the last time you did a lifeboat drill with your clients or discussed a lifeboat drill with your pipeline of prospects? More importantly, when did you review their portfolios and goals and ask if they were still aligned?

  • Are they allocated exactly the way they should be – in the right strategy and right investment philosophy, or are they just watching the portfolio balance and “letting it ride”?
  • Are they avoiding an optimal portfolio because of not wanting to pay cap gain taxes (see John Frownfelter’s article Taking the Bull by the Horns)?
  • Have you told them, in real dollars, what a 10%, 20%, or 30% correction would look like to their balances or their spending if they are living off their portfolios?

I have no idea what is going to happen in the markets, but I do know that today is the day to have the conversations. Actually, yesterday was the day but since that is gone, today will do just fine.

Lifeboat drill for you, too

While doing this lifeboat drill, it also makes sense to do the drill for your business. Are you fat and happy or complacent? The same PriceMetrix study that showed increasing AUM for the average financial advisor also showed that the average revenue on those assets are steadily decreasing. In other words, while you are still earning more than last year, the margins are smaller. Ask yourself what happens to your business, in real dollars, if your AUM drops by 10%, 20%, or 30%? Ask yourself:

  • Are there changes in your book that you can make, such as commission to fee or traditional investment theory to goals based?
  •  Do you have multiple platforms causing inefficiencies that you can trade for a single platform?
  • What are the inefficiencies in your practice you can take away right now? (In other words, what do you do that is non-revenue generating?)
  • Take a look at gross assets versus net revenue – are you where you want to be?

As I said, the time is now. Don’t forget the lessons of the past. In March of 2009 or October of 1987, you were too busy earning your fees by holding the hands of panicking clients. Are you earning your fees today?


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John Anderson

John Anderson

John Anderson is the creator and lead author of Practically Speaking blog and Managing Director of Practice Management Solutions for the SEI Advisor Network.

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