Understanding why you’ve been successful is important to sustaining your success.

Porsche made its mark in auto racing in the 1950s by turning the race for better power-to-weight ratios on its head.  While most automakers focused on the numerator, building bigger cars with more powerful engines, Porsche worked to keep the cars light — not only to improve acceleration but also braking and handling.  The formula worked both on the track and in the showroom, and Dr. Ferry Porsche never lost sight of what made his cars competitive and sought after.

In sharp contrast to the monotonous sea of three-ton SUVs, the 9^th generation 911 stays true to an identity that Porsche established in the 1950s with the 550 Spyder and the model 356.  Although the 911’s weight has crept up over the years, power increased even faster.  Engineering advances have added double-clutch gearboxes, all-wheel drive, four-wheel steering, ceramic-disc brakes, and (to the horror of the Porsche faithful) water-cooling to Porsches.  However, the core identity of the product has remained intact and forms the intangible that Porsche has monetized for over 70 years.  The waiting list for a new one is as impressive as the sticker price.

To the surprise of many, it’s been another very good year for the RIA community.  Markets, on the whole, are strong, tax rates haven’t skyrocketed (yet), margins are thick, and transaction activity continues unabated.

Success, alas, can be fleeting.  While some in the industry are focused on continued opportunities and upside in the years ahead, it’s hard to ignore calls that corporate earnings growth may slow, the Fed has pivoted to defense, political tensions are worrisome, emerging markets are still underperforming, fee pressure has not abated, and the world seems to be constantly threatened by another exotic communicable disease.  Whatever brings about the rollover in industry trend lines, we all know it’s coming at some point.

So, if 2024 is indeed the peak of the cycle for the investment management industry, what will you one day wish you had done now?

1.  Know What Got You Here

There’s an old proverb that says something to the effect of every ship has a good captain in calm waters.  If your RIA has grown in AUM, revenue, and profitability in the years since the credit crisis, you’re not alone.  Think about why your firm grew.  Did you add productive financial advisors to your wealth management practice?  Did you add attractive asset management strategies?  Did your assets under management increase because you broadened your appeal to a larger range of clients?  Did you develop deeper relationships with existing clients?  Did you grow organically?  Or was most of your growth the result of acquisitions?  Are your effective fees charged steady or increasing?

Look at whether or not your AUM grew because of market tailwinds or because of new clients.  Bull markets come and go, of course, so building the fundamental value of your investment management firm is really contingent on having an asset acquisition strategy (i.e., marketing) to bring in new clients and new client assets net of terminations and client withdrawals.  You will always face some client terminations — you don’t want to do business with everyone anyway.  Even good wealth management clients will eventually spend their money, and institutional asset management clients will reward your outperformance by rebalancing their commitment to you.  Some attrition is unavoidable and, ultimately, healthy.  You just can’t rely on favorable markets to keep your revenue base stable or growing.

2.  What Will Your Firm Look Like in Five Years?

Corporations can be perpetual, but the people who work at them eventually leave.  Because investment management is necessarily labor intensive, your firm is a function of the career cycles of your staff.  Five years from now, everyone who is still at your firm will be five years older.  Stop for a minute and think about what that looks like.  The RIA industry is, as a whole, facing demographic challenges, and by some measures, there are more financial advisors in the career wind-down stage than there are in the career development stage.

So what will your staff look like in five years?  Will any of them have retired?  Will anyone have new skills and/or credentials?  How will titles, roles, and responsibilities change?  What turnover are you likely to have?  Will you need to replenish turnover from experienced hires, or will you train people who are new to the industry?  In other words, as you look at the changes that will likely happen to your staff over the next five years, will those changes grow your firm, maintain it, or are you at risk for attrition to your collective intellectual capital?

3.  Stress Test Your Margins

It’s more than a little ironic and unfortunate that there are so many forecasting tools for individuals but so few for businesses.  Just like wealth management firms run Monte Carlo simulations on portfolios to model likely outcomes for clients given different market scenarios, so you, too, need to think about how your firm will fare during unfavorable external circumstances.

Profit margins have a very real business continuity function that is easy to forget after long stretches of upward-trending markets.  If your firm currently boasts a 25% pre-tax margin, for example, you could suffer the loss of a quarter of your revenue stream and, theoretically, not have to cut your expenses.  This isn’t pleasant to contemplate, but if a sustained bear market cuts your AUM by 20%, and then client financial stress causes a greater-than-usual rate of withdrawals, you could see a considerable decline in your top line.  Since the only way to meaningfully reduce expenses in the RIA business is to cut staff, responding to unfavorable financial market conditions can have a long-lasting impact on the scale and value of your firm.  It’s worth considering such a likelihood, and it’s much easier to do so with a clear head when you aren’t under the stress of the event itself.

4.  Consider Your Exit Options

With M&A on the rise, private equity increasingly interested, and new consolidation schemes emerging on a weekly basis, there has never been a more interesting time to consider how you might liquefy an interest in an RIA.  Remember, though, that most ownership transitions in investment management firms are still internal because transacting staff, clients, and culture is difficult, even with favorable industry conditions.  Outsiders don’t always “get it,” and insiders don’t want them.

If you had to sell right now, how would you do it?  If you don’t think your firm is ready to take to market, what changes need to be made?  If you intend to transact internally, do you foster a culture of succession?  There’s no room here for an exhaustive analysis of exit planning for RIA owners, but suffice it to say that you should always be aware of your possibilities.  If you can’t find the door in good times, what will your plan be following the next correction?

5.  Remember That Long-Term Industry Trends Are Favorable

At some point, things are going to get rough, and the performance of your RIA is going to deteriorate.  When market valuations tumble, clients get nervous, and staff stress rises, it can feel like at least your professional world is coming to an end.  Broad industry trends, though, are very favorable to the investment management community.  New retirees make up the largest source of new clients for wealth management firms (and, in turn, asset managers), and the number of retired persons in the U.S. will continue its upward trajectory for decades to come.  Assets continue to flow away from wirehouses and toward independent advisory practices.  And last but not least, markets are — over time — upward drifting.  None of that is going to change with the next bear market.

While the fundamentals of your firm may appear to deteriorate during bear markets, the fundamentals of the industry will continue to drive success for a long time.  Today, the fundamentals of your firm are probably the best they’ve ever been.  That’s why this is the perfect time to consider your formula for success, prepare for the next downturn, and build the competitive momentum you’ll need to ride the industry trends to greater success in the future.