Those who fared best stressed financial planning over asset management.

Contrary to popular mythology, not every financial advisor survived the great bear market of the last three years. And those who did were put to a test that turned out to be more severe than they had ever expected.

A recent advisor benchmarking study conducted by Rydex Funds manages to quantify some of the pain. Between, 1999 and 2002, RIA firms suffered an 18.4% decline in their assets under management, falling from an average of $87 million to $71 million. Revenues dropped almost 12% to $795,000, profits dropped by 26% to $210,000 and profit margins contracted by about 25%.

But advisors' performance was uneven. While some were forced out of the business, others managed to grow. According to the Rydex study, RIAs saw their client base increase by 8.1% in 2001 and a remarkable 21.7% in 2002, as shell-shocked investors sought help in unprecedented numbers. Interviews with advisors who survived and with one who didn't reveal a lot about this emerging profession and which firms were built to last.

Gary Freiberg, a former registered rep now living in San Luis Obispo, Calif., remembers the markets of 2000-2002: "When the market changed [in 2000], I opted to stick with the fundamentals, to stay diversified. In previous downturns, markets recovered quickly and, this time, everyone expected the same thing to happen. At some point, I was sure it couldn't go down much more. I remember thinking ... 'I can't sell now because my clients will have all these losses,' so I didn't do major overhauls of my portfolios. I stuck with what I believed were good four- and five-star funds. I believed in the expertise of the managers I'd selected. As a result, I lost clients, some big ones. Maybe they were hoping someone else could get a better result or, in a couple of cases, they decided to self-manage their portfolios at Schwab. It was disheartening to talk to clients when I had nothing good to say. My credibility was irrevocably damaged when we did poorly ... along with the market and the entire securities industry."

Now the owner of a successful start-up business totally unrelated to financial services, Freiberg says he cared deeply for his 250 clients and respected the trust they'd put in him, but didn't see any alternative to selling his business. In 2001, when he first considered selling, Freiberg listed his business with FPTransitions.com, the industry's premier market-maker for financial advisory practices. David Grau, FPTransitions' president, explains that Freiberg wasn't ready to finalize a sale for about a year and a half after he initially listed. "By then," says Grau, "his annual revenues were off by about a third, and his initial listing price was down 55% reflecting the recent, sharp decline in his revenue numbers."

How could this have happened? Freiberg was certainly not the only advisor forced out of the industry by poor investment performance and dwindling client numbers. But at the same time, many other advisors not only stayed in the industry, but thrived during the 2000-2002 market. The answer may go back to the predictions made in the mid-'90s by of a small number of astute observers. What they said was that advisors gathering assets without providing a solid foundation of financial planning advice will suffer if and when a market downturn arrives.

Says Freiberg, "I viewed myself as an investment advisor. The label 'financial planner' had the connotation of working on budgets. I figured wealthy clients had reached their level of wealth without my needing to work on their budgets with them, and financial planning was unnecessary."

While Freiberg's perception may have fairly characterized his clients' own perceptions of themselves, some would argue that he nevertheless should have overridden his clients' possible objections to financial planning in order to create more stability for his business.

Says Jeffrey Hill, CFP with LPL Financial Services in Denver, Colo., "I've provided financial planning services through the market downtown and believe it's been integral to maintaining clients. I've lost only a couple of clients due to low returns, and they were clients with whom I didn't take a holistic approach. They were just money management clients with no financial plan."

Charles Foster, one half of Blankinship & Foster in Del Mar, Calif., can empathize: "We lost a number of clients in 1999 and 2000, maybe 14 out of 250, the ones who'd come in in 1997 and 1998 and didn't want us to do any financial planning."

Hill compares two of his clients who both lost a lot of money in the market. "One couple was freaked out, so they just cashed in [and left me]. The other cashed in too, but is still with me as a planning client. He's now beginning to go back into the market."

And this is the crux of the issue, most survivors say: Simply managing money doesn't allow the advisor to develop nearly as high a level of understanding and mutual trust with his client as does the financial planning process. Done right, planning leads to the cultivation of a deep friendship with far deeper roots than are possible with money management alone.

The irony of this realization is that many survivors have remained successful in spite of using a fee structure-percentage of assets under management-that doesn't obviously credit them for the planning work they do. In many cases, advisors who kept their clients still lost significant revenues, because the income was tied solely to investment performance. What saved them, many say, was the falling market motivating many do-it-yourselfers to seek out advisors, resulting in large inflows of new clients to offset revenue declines from existing clients' diminishing principal.

Even before the markets began their decline, advisors were experiencing another threat-client greed. Says Foster, "In 1999, after realizing AUM increases of 25% a year, growth slowed. Clients were becoming less satisfied with their investments, increasingly expecting us to recommend aggressive stocks, which we refused to do. Although many other advisors I talked to were [financially] injured during this period, we mainly got our egos hurt because clients didn't believe us and challenged our philosophies." In 1999, his company's assets under management growth rate dropped to 7%; in 2000 and 2001 it dropped to 3% and 6% respectively; but by 2002 it was trending back up again.

As a result of the 2000-2002 market and the client mania that preceded it, many advisors, including Foster, took deliberate survival measures. "What we did in 1999 and 2000 was to cut back unnecessary expenses," Foster says. However, like so many optimists, he and his partner believed the worst was over in 2001, and they hired two new planners. That year they experienced their biggest-ever down-year for revenues, along with their biggest ever jump in expenses. They got through the hard times by dropping their client minimum from $1 million in assets to $500,000, thereby attracting new clients who's work they could feed to their new hires.

Likewise, Hill took some extraordinary measures to bolster his business during 2000-2002, and to stabilize it even further should a rocky market challenge him again in the future. "I used this brutal period in the financial markets as a lesson to learn and move forward from," explains Hill. "First, I performed more services for existing clients, so they could get some value-added. A client in Mexico (Hill has many international clients), for example, might be traveling to the U.S., so we would book him a hotel room."

Second, he began testing out a partnership with several associates. "I'm going from being a sole practitioner to building an ensemble practice with partners, which is lowering overhead and allowing me to work on the structure of my business." Hill has teamed up with two other LPL reps who, like himself, have 20-plus years of experience, in what he calls a "courting" period, to see if they want to combine their practices. At the same time, they're adding a new practice focus-real estate-something Hill says, with the exception of a few REITs, hasn't been an asset class for his clients. "We believe the sizable generational transfers soon to take place will have a large real estate component, so we've gotten involved in 1031 exchanges, spending a lot of time on education and due diligence," says Hill.

Not only does Hill hope clients will find his additional expertise a reason to stay, but he reasons that having a larger organization should also help with client retention. Alan Goldfarb increased the size of his organization, as well, by merging with the 50-year-old regional CPA firm of Weaver and Tidwell LLP in Dallas-Ft. Worth to become Weaver and Tidwell Financial Advisors. Unfortunately, just like Foster's optimistic but ill-timed overhead additions, Goldfarb's timing led to problems initially.

He explains, "We merged our fee-and-commission RIA, Financial Strategies, into the accounting firm in 2001 with great expectations and a viable business plan, only to see it shattered by the market ... to the ire of the accounting firm." But what he did to turn around the situation is instructive.

"We liked the idea of our clients having access to top accounting people, and the principals of the CPA firm wanted to be able to offer financial planning services to their clients. We expected to create an RIA subsidiary of financial advisors and to acquire assets. We brought most of our own clients with us, representing about $22 million of assets when we merged, and our goal by the next fiscal year was to have $100 million under management from all sources," says Goldfarb.

Unfortunately, the market decided not to cooperate, and Goldfarb didn't quite make it. Not only did he have to concern himself with his own clients' reactions to lost principal, but also the reactions of his prospective CPA firm clients. "The clients of the accounting firm didn't want to have anything to do with us because they were frozen in fear, as were some of the partners. The partners we had negotiated the merger with were still comfortable with our relationship, but the other partners needed a lot of personal interaction in order to offer up their clients to us."

This is where the story ties back into our main theme, but with an ironic twist. Reports Goldfarb, "The CPAs didn't want us to worry about the financial planning, an approach I've seen before with accounting firms. Yet, what they needed to understand was that we believed it necessary to do comprehensive planning and money management together." What Goldfarb and his group finally did was to bring education to bear on the problem, education not only for the accounting firm's clients, but for the partners, too. "By way of seminars, we tried to build the clients' and partners' trust in our services, discussing planning issues such as 529 plans, long-term care solutions, etc. We started to get some more interest, but it took a while to build their comfort level. Now, in this, our third year, we're on target to hit our $100 million-under-management goal," he adds.

Ultimately, it was Goldfarb's emphasis on financial planning as a context for money management that allowed him to preserve the deal he'd structured, gain the trust he needed from all parties, and achieve his goals.

"The CPA firm was much like many of our clients-focused on the easy money," Goldfarb says. "It's so tempting to look at the profit and loss statement of a comprehensive planning and money management operation and say, 'It's clear that we've got two divisions, financial planning and money management, and the first has a very narrow profit margin while the second a very generous one. The solution is simple: jettison the planning and emphasize the money management.'" But as savvy advisors know, these services aren't separated as easily in reality as they are in one's accounting ledger. It might be possible to distinguish them on paper, but they are entirely co-dependent in the real world. The actual service and its inevitable profit margin is the consolidation of the two divisions.

The epilogue to Goldfarb's story is that his seminars did the job. He says, "The accounting firm 'gets' it now. They understand the importance of the planning element in what we do." Not only has he gone on to new ventures within the firm, most notably creating its own insurance agency, but he also introduced a discounted planning service to the 22 partners of the CPA firm. "Three took us up on it. We did planning for them, and now they are our greatest allies within the company."

Looking back at the 2000-2002 market, and all of the changes it has forced on the financial services industry, it's tempting to say that all financial advisors have struggled equally. But is that really true? It seems quite possible that broker-dealer reps have struggled even harder to survive than independent RIAs, particularly in the wirehouse sector, where gathering assets is the key to compensation and financial planning is sometimes an afterthought or a loss leader.

From its 2003 Annual Salary Survey, in which the vast majority of respondents describe themselves as "stockbrokers," "reps" or "financial advisors," Registered Rep magazine reported in its June 2003 issue that assets under management for this respondent group fell 41% in 2002 over 2001, accompanied by a 20% drop in reps' gross production. These statistics bolster the argument that clients tied to their advisor solely by investment performance expectations had little reason to stick around when the markets got ugly.

Like some CPA firms new to financial planning, the wirehouses and other large institutions are attracted to the quick profits in managing money. Yet, anecdotally at least, it appears that those clients who invested within a strong financial planning framework-something much more likely to have occurred on the independent side of retail financial services-stayed and, with their advisors' help, sought to understand how the market setback would affect their long-term financial prospects. Reinforced by the 2000-2002 markets, professionals learned once again that high return is generally accompanied by high risk, and money management without financial planning is a shortsighted business model.

David J. Drucker, MBA, CFP ([email protected]), a fee-only financial advisor since 1981, is editor of the Virtual Office News monthly newsletter, and co-author of the book Virtual Office Tools for a High-Margin Practice (Bloomberg Press, 2002), both available at www.virtualofficetools.net.