Financial advisors are always susceptible to market changes that could have a huge impact on their future business. Their firms can be affected by a variety of market gyrations, new regulatory initiatives, or the nosedive of certain asset classes in which their clients are invested. Accordingly, astute advisors should have plans in place for how to react to varying scenarios.
The Bull Keeps Running
Most advisors have not considered the possibility that the U.S. stock market may be experiencing an extended bull run — that the run-up is not yet near its end. Corporate profits are seeing a long growth curve, as well as innovations in the biotechnology and information science sectors. The markets have also experienced a period of low inflation and low interest rates, as well as business efficiency improvements, due to the increased use of big data, mobile technology, specialized apps, social media and outsourcing. So advisors need to prepare for the fact that the bull market may, indeed, continue to run strong. (For more, see: How to Be a Top Financial Advisor.)
Things Fall Apart
Another scenario has the Federal Reserve Bank reacting aggressively to signs of inflation and decide to raise interest rates by increments of 50-basis-point at a time. China's economy could slow further if follow-on measures to prop up its markets and banking system prove ineffective. Europe, too, could experience a deflationary period, while in the U.S., Wall Street may be cooking up more ways to increase profits that could affect the general population. So advisors should be asking themselves whether or not they have prepared their business and their clients for a steep drop (40% of more) in the U.S. stock market. (For more, see: 7 Lessons From a Market Downturn.)
Stuck in the Middle
Some market players have been predicting that asset classes will deliver sideways real returns for the next decade. If this scenario takes place, the traditional retirement models would be turned on their heads, and clients will become generally much more cautious about spending. Investors may even start to question the value of hiring a financial advisor or portfolio manager. So advisors need to figure out how they will respond if market returns end up being about equal their annual asset under management (AUM) fees (such as adding more services). (For more, see: Finding Value in a Sideways Market.)
Given these scenarios, how is an advisor meant to prepare and react?
Adjust Fee Models
For many advisors, when the market is up and client portfolios are ballooning, it makes sense to charge fees based on asset under advisory. But it markets falter, this could come back to bite them. A prolonged bear turn would mean that AUM revenue would decrease with stock value. As client portfolios shrink, there will be pressure to lower their fees as clients react to seeing most of their portfolio returns go to their advisors. Accordingly, advisors would be well-served to shift to annual retainers. Such a move would cap potential revenue upside, but protect advisors from losing too many clients. (For related reading, see: Six Things Bad Financial Advisors Do.)
Planning Services are Key
When stocks are surging, many investors tend to move away from a conservative, diversified portfolio in favor of high-flying stocks. That's something most advisors would warn against — possibly to their detriment. Simply put, advocating for a conservative, diversified portfolios could cost you clients if the stock market is reaching lofty heights.
To deal with this potential issue, advisors must be ready to prove to clients that their value proposition was in the financial planning services they offer, rather than their portfolio management skills. The same message applies to the value they offer in a bear market. Financial advisors can help clients not only with investing decisions, but with providing professional advice, estate planning, coaching, and tax management. These skills apply in any type of market. (For related reading, see: How Financial Advisors Can Adjust to Robo-Advisors.)
That said, the best way to deal with a market downturn or a sideways market was to lower fixed costs, the cost of which could be done by outsourcing, adding new technology tools and workflows, and including an incentive structure for staff. That may include giving employees a lower base salary with a higher potential reward during bull markets and a bonus tied to the firm’s performance.
Another potential problem is increases in compliance costs and potential hassles that could arise from initiatives that the Securities & Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) may come up with to regulate registered investment advisors. Smaller firms should consider consolidating to both create scale and to make it more affordable to hire compliance professionals, who can take over some of the added paperwork and regulatory oversight. (For more, see: Financial Advisors are Feeling Cyber-insecure.)
The Bottom Line
Advisors need to be prepared for all the various market scenarios that may occur. That may include taking up a retainer revenue model, promoting the financial planning aspect of their business and creating an incentive compensation structure for employees. Advisors should also seek out ways to better use technology and consider the advantages of merging with another firm. (For more, see: Growth Strategies for Financial Advisors.)