3 Lessons on Growing your Financial Advisory Practice from Warren Buffett
I recently finished reading Warren Buffett’s Letters To Berkshire Hathaway Shareholders 1965-2013 as well as Michael Kitces’s recent blog posts about the threat of robo-advisors. Having read these pieces it made me think….
What would Warren Buffet do if he were the owner of a financial advisory practice?
Many of the stories about Warren Buffet’s success focus on his investing prowess but little is dedicated to him as a business owner. After reading his shareholder letters I’ve come to believe there is a lot the advisory community can learn because let’s face it – things are going to get tougher.
Competition from traditional advisors is rife. According to Cerulli Associates there are about 310,000 financial advisors of one type or another. In the U.S. there are about 5.2 million millionaires. That makes about 17 millionaires for every advisor. Not exactly a lot when you factor in salaries for support staff, marketing and technology expenses. If we add robo-advisors on top it gets even more competitive.
So how can you grow your business using the wisdom of one of the greatest business owners of the 20th century? Let’s find out.
Lesson 1: “…producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.” – 1978
When Buffett wrote these words he was talking about the textile industry and you are probably thinking financial advisory is not a “capital intensive” business but work with me for a second. Think about the cost to find, hire, train and support a new advisor. It’s certainly not cheap. Then think how long it takes for them to develop a book of business that supports them and generates profits? Is it a year or longer?
If we compare financial advisory to other service businesses such as software development consultancy, accounting, advertising you will find these other businesses tend to hire when they have too much work (meaning a new employee can usually earn their keep within 90 days). It’s a lot more transactional and easier to scale.
But with advisors hiring a new employee is more of an upfront investment, which pays off over a longer timeframe. This is because advisors must build trust to win clients and that typically takes longer than completing a tax return or managing an ad campaign. Thus I believe within the service economy financial advisory is capital intensive.
If you agree with my logic then the only conclusion (given the large supply of advisors) is that differentiation is the key to growth. As Kitces says “building a well diversified passive strategic portfolio is on it’s way to being totally commoditized”. So if you fall into that group you must differentiate. This would require something that goes beyond portfolio-only solutions and is a lot more comprehensive or specific/niche.
So lesson number one from Buffett is differentiation.
Lesson 2: “The primary test of managerial economic performance is the achievement of a high earnings rate of equity capital employed.” – 1979
One of the most remarkable things about Buffett is that he chose one metric that matters for his business and stuck with it for years. In his case ROE/ROCE. Other metrics matter too but they are of secondary importance.
What’s the one metric that matters in your business and do you watch it on a weekly or monthly basis?
Let me give you another example. For Pocket Risk our one metric that matters is the % of customers who complete a questionnaire each month. This is because the value of Pocket Risk is in completed questionnaires advisors can assess and use to determine a financial plan. Customers who complete many questionnaires are happy and do not churn. We could have used a vanity metric like logins (which is higher) but value is not derived from logging in, it is derived from client engagement.
At first thought you may think AUM is your one metric that matters but we know that all AUM is not created equally. You will need to determine the metric or metrics that matter to your business. If I were an advisor I imagine it would be a formula that calculates the profit per customer (accounting for acquisition and support costs) on the front end and client churn on the backend.
So lesson number two from Buffett is find the metric or metrics (I doubt you need more than three) that are most important in your business and measure constantly. As Peter Drucker says “what gets measured gets managed”.
Lesson 3: “It is impossible to overstate the how valuable Ajit [Jain] is to Berkshire. Don’t worry about my health: worry about his.” – 2000
“If Charlie [Munger], I and Ajit [Jain] are ever in a sinking boat – and you can only save one of us – swim to Ajit.” – 2008
How many of your employees do you speak of in such terms? Buffett’s brilliance is also in his ability to find and nourish great people. Sure he wants them to be hard working, smart and honest but he also wants them to be self-directed. He wants them to have the mindset of a business owner. Micromanaging your team means you cannot scale therefore you cannot grow without adding layers of management. To avoid this you need your employees to have the mindset of a business owner.
Judging from his letters Buffett didn’t spend much time trying to train people to think this way, he found people who already had this mindset. However, I think you can train people to think this way if you give them the power to make important decisions. You have to trust them. Trust however, has to be earned and you will probably need to do this over time. Just remember there has never been a great organization without great people.
So lesson number three from Buffett is find employees with a business owner mindset who can be almost totally self-directing.
Concluding Thoughts
Given Warren Buffett has been one of the most successful business owners in the 20th and early 21st century it pays to listen to his advice. As a financial advisor I encourage you to think more about differentiation, the one metric that matters in your business and improving your team.
I’d love to get your thoughts in the comments below. What do you think advisors can do to grow efficiently, effectively and sustainably in the years to come?
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