An aging client book will in five years time be one of the biggest issues facing advisors trying to grow their business, Johann Schneider of US-based Russell Investments told Family Wealth Report.

An aging client book will in five years
time be one of the biggest issues facing advisors trying to grow their
business, Johann Schneider of US-based Russell Investments told Family Wealth Report.

Schneider, program director for capital
market insights, works with financial advisors through Russell to help analyze
and value their businesses. He outlined two ways advisors can protect themselves from the perils of an aging client book: diversify the client base and recruit younger talent. 

“One of my observations is that the age of
the clients in the book can have a significant impact on the value of an
advisor’s business,” he said. “When advisors have an aging book of clients, the
future growth potential of their firm is often threatened.”

According to 2012 figures from Cerulli
Associates, the average age of US financial advisors was 51.5, with more than
50 per cent of them older than that. Advisors meanwhile - the largest cohort of
which is in the Baby Boomer generation – typically have clients that are aged
plus or minus five years of said figure, Schneider said.

This, combined with the aging demographic
generally, means many advisors may start noticing that their client base is
getting older – and this can have a significant impact on the value of a firm.

Schneider underlined three groups of
advisors who will be most influenced by this. They are: those looking to sell
their firms over the next three or five years; those who are buying other
wealth managers; and those who are simply trying to build a sustainable
business.

For context, he observed that the
typical path an investor usually takes can be summarized in terms of 1) wealth
accumulation (during which investors contribute to their retirement assets and
wealth grows at an increasing rate) 2) peak wealth or “maximization” (the
portfolio returns outpace withdrawals) and 3) retirement or “decumulation”
(when income distributions start to exceed investment returns and wealth
decumulation begins to quicken).

It is at the peak wealth phase when clients
will have the biggest impact on advisors, and this tends to occur between the
ages of around 65-75, Schneider noted.

But as that cohort begins to age, they slip
into the “decumulation” phase, whereby clients begin withdrawing more assets
from their retirement plans than they’re putting in. Business will,
consequently, find it increasingly difficult to grow.

“It’s compounded by the fact that most
advisors, if they are at or near retirement age, have many clients in their
peak wealth phase. So this problem of an aging book and of future decline and
revenues, due to assets being drawn down, is hidden by the fact that many of
these people are at their peak wealth,” Schneider said.

Considerations

Schneider highlighted how older, retired
clients tend to have more conservative portfolios, with less growth potential.
He added that many of the advisors he’s describing now built and started their
businesses in the ‘80s and ‘90s - they had 20 years of extremely positive
returns and didn’t have to do as much to grow. But today, he said, we’re in a
much lower expected return environment.

“Although we’ve had a strong year in the
equity market, our capital markets forecasts expect to have lower returns going
forward and certainly not what we’ve experienced in the recent past. This puts
even more pressure on advisors to be able to grow their business through other
means – they can’t just rely on the markets to make stronger returns. That,
coupled with the fact that they have older clients on their books, is creating
more of a challenge.”

Meanwhile, Schneider pointed out that many
advisors are thinking about retirement over the next five to ten years - they’re
thinking about exiting strategies and selling up.

“If a buyer comes in and sees that the
growth potential of the firm is threatened because of this aging client book,
it’s going to decrease the value of that potential sale,” he warned.

This is a huge topic and a trend which
Schneider said he thinks has become more apparent in the last couple of years.
And there are a couple of things that are happening all the while, he noted.

“More and more people are thinking about
succession planning, or thinking about the valuation of their firms and how
they’re going to pass on their business from one generation to the next.
They’re thinking about using their wealth management firms as a retirement
vehicle. Thinking about those big issues like ‘what am I going to do when I
retire’ and ‘what is my business worth to me?’. The secondary question becomes:
what are the things that influence those things?

Awareness

Indeed, many advisors have already started
to observe this as a current trend or future challenge they may face. But others think “well that’s not me yet…that’s at least five years out,” Schneider
said.

He explained: “I’ve experienced some
pushback on the idea, but I…try to take real data and show them what the
projections look like. I think that tends to make a point, but those are people
who have engaged with somebody to try to understand and strategically enhance
their business. For everybody else, who I guess are less aware of this issue, I
think it is a challenging one. One, because it’s in the future and hard to see,
but…the true value of one’s business is not dependent on what happened in the
past but what’s going to happen in the future.”

Additionally, he noted that many people
will say “sure, I may have some older clients but I only focus on high net
worth individuals” - but this approach is certainly not risk-free either. While
these advisors may not be at risk of declining assets, they might have another
type of risk, which Schneider described as “asset flight risk.”

If an advisor is working with someone who
has $10 million or $15 million to invest, for example, it is “unlikely that all
of those assets will stay with the advisor for the entire time there,”
he said. They are constantly going to be seeking out other return
opportunities.”

When money runs out

From the investor’s perspective, money runs out “all too often,” Schneider added. “What many advisors don’t see is that,
because they haven’t worked with as many people who are in retirement, they
haven’t seen the impact of what can happen when those assets start to draw down
and the impact on advisors’ businesses.”

While he acknowledged that advisors are doing a pretty
good job at building portfolios that will sustain their investors, the problem
is that those portfolios, naturally - by the laws of math - tend to decline
over time because the withdrawal rate is often greater than the returns.

Ultimately, Schneider said advisors will
have to start to run their businesses differently. They'll have to target a
younger age cohort of clients, and possibly change how they build and maintain
businesses going forward to adapt in an environment where people are “just
getting older.”

One way advisors are combating this
issue is by expanding their service team.

He explained: “If an advisor is feeling the
pressure form an aging book, one thing they can do is hire a younger person on
their team and have them go out and get new clients in the age cohort that
makes the most sense. One rule of thumb that I like to give people is that for
every client over the age of 75, try and have one or two between the ages of 55
and 65. Even better is to get someone who is looking at clients in the younger
range, say 45-55. It’s difficult because often advisors don’t see as much
potential in those age groups simply because they don’t have as much money.”

And much of the matter boils down
to simply diversifying the client base to create more space for younger clients. However, “you’re going to see many advisors
just ignore it,” Schneider said.

While the demographic makeup of the world’s workforce is changing
because people are living and working for longer, the demographics of
the financial advisory industry are “continuously skewed towards older
advisors,” Tyler Cloherty, senior analyst at Cerulli, previously told Family Wealth Report. “Most clients want to deal with someone who is about their age, and
people’s financial wealth peaks in their fifties and sixties, which is
why you see assets peaking for advisors within those age ranges as
well.”