Journal of Financial Planning: December 2011
Ross Levin, CFP®, is the founding principal of Accredited Investors Inc. in Edina, Minnesota. His new book Implementing the Wealth Management Index, published by Bloomberg Press, is now available. His email is ross@accredited.com.
When my partner Wil and I got out of our car in the Wendy’s parking lot, Wil had opened his car door and a huge guy jumped out of his car next to ours. He was wearing a tattered shirt and had a wild-eyed look and untamed hair. This behemoth was gesturing wildly and yelling at Wil for an alleged door nick. When Wil asked him to show him where, the guy pointed at a spot on his littered-with-dents car. Wil calmed the guy down, and we walked somewhat shaken into Wendy’s to plan our future. This was our moment of truth. We had been partners for a couple of years, our business was really struggling, and we were not sure that we could continue.
As we sucked down our giant sodas, we began to write on a napkin the things we needed to do to succeed in business. One of them was to stop going to Wendy’s during the middle of the day to complain about our business. But some other things we tried to figure out were who we wanted to serve, what service we were going to offer, and what things would look like if we were successful. We decided that we no longer wanted to accept commissions, even though our fee revenues were relatively paltry. And we discussed which clients were the best fit for this new model. By the end of the meeting, we felt like we’d created marching orders for ourselves that would hopefully pay off down the road. What we didn’t know was that we were using a form of Bayes’s rule to do so.
Anyone who has ever done a Monte Carlo simulation has used Bayes’s system, where we “modify our opinions with objective information.”1 As I read Sharon Bertsch McGrayne’s book, I realized that while we recognize how we make decisions under uncertainty in investments and wealth management, we also do so in how we build our businesses. Bayes’s system is about conditional probabilities. What are the outcomes most likely to occur given a wide variety of inputs and how they impact each other? When we think about our businesses, we are constantly making decisions that will have a long-term impact and will affect our futures, but I wonder if we should be making these decisions using a formal, probability model. Here are some things to think about.
New Business
There are many ways to try to get clients. Some people are experts at giving seminars, some people work wonderfully with centers of influence, and some people generate referrals. And there are various types of clients with whom we work best. Some practices have many executives, others work well with people in transition, and still others have built practices through specializing in working with doctors. Each of us brings a certain set of characteristics that will play better with a certain type of individual. Some people love to get deep into details and work well with others of that profile, and others are relationship people who enjoy forming intense relationships.
When you think about it, isn’t this in some ways a Monte Carlo simulation? Method for attracting clients is a variable, profession or income of clients with whom we work is another, as is our preferred client personality types. So as you build a practice, where is your greatest probability of success going to occur?
I think this is important to consider because we often spend too much time working in areas in which we think there may be high potential payoff, even if there is little likelihood of success. When I was 30, I had a difficult time working with people with a lot of money. I was emotionally unprepared and uncomfortable in certain situations. When I got in front of people with means, I would fret about the appointment before and after. When they chose to work with someone else, I attributed it to my inability to close the deal or to express myself well, rather than to their good judgment.
As I look back over our business now, there are certain truths I am more willing to face. My greatest successes continue to occur in areas in which I have the highest probability of succeeding. The new clients I attract at 52 are different from those I attracted at 32. The way we got out of our Wendy’s rut was that we honestly looked at ourselves and our practice and determined with whom we had the greatest chance of succeeding.
This meant we took our existing client base and looked at who had showed comfort in giving us referrals. Our old approach was to go to our biggest clients and try to get referrals from them, even if their profiles were not likely to give them. We may have had clients who loved us but didn’t refer to us. On the other hand, certain clients loved to give referrals. By really engaging those clients and asking them to help us grow our business, we began to meet better prospects.
We also looked at which type of client resulted in the most success. At that point in our careers, it was with young doctors. We began to build an expertise in working with doctors and determined that by finding physician groups, we would stand our best chance of success. After we were working with a couple of doctors in a group, we would meet with the group’s practice manager to go through our clients’ benefit programs and buy-ins and discuss other issues. These practice managers often served multiple practices, so we began to expand this part of our business.
As we slowly developed this approach, a funny thing was also happening: we were getting older. This meant that we had been in the community longer, had developed more contacts, had more people closer to our age beginning to have money, and had more clients and therefore more referrals. Eventually, as with anytime one deals with uncertainty, unexpected events occurred. As our business grew, we got referred to a couple of large clients who also happened to be referrers. But only by focusing on the high-probability events were we able to be around long enough to experience the low-probability, yet rewarding, events that helped fuel our growth.
Staffing
I think staffing is also an area in which you can use Bayes’s theorem to try to increase your odds of success. We now have 37 people in the company, but that has taken us years to build and grow. What we know, though, is that certain characteristics or skills have increased our odds of hiring success.
For example, we have had the most success with accountants when hiring experienced professionals. We have had the least success when hiring people from large wirehouse and banking environments. As we feed in future probabilities, we need to focus on those areas in which we have been successful. Although it is certainly possible we can find a good hire from a wirehouse or bank, it appears this may be a low-probability event for our firm (I am talking exclusively about our firm).
We have had success hiring from some of the outstanding college programs. But again, one of the things we have had to seriously consider is the likelihood of whether someone who has gone through an out-of-state college program will stay in Minnesota. As I have mentioned before, some of our best hires from these programs moved back to their home states even though they were enjoying their careers here.
Existing Clients
One of the things all firms need to confront is the demographics of their client base. Again, if you break down your client base by age, you may be able to create probability of expected future revenue streams. Clients are often initially accumulators, but eventually they begin to spend their portfolios. We look at this in terms of business risk, because we want our clients to be able to comfortably live off their assets, yet realize that over time those clients will not grow. Therefore, we need diversification among client lifestyle stages.
In McGrayne’s book, she says philosopher David Hume believed that “because we can seldom be certain that a particular cause will have a particular effect, we must be content with finding only probable causes and probable effects.”2 As you begin to look at your business, focus on the things you can do that give you the greatest chances of success. Although it is often painfully obvious, it can be surprisingly difficult to do.
Endnotes
- McGrayne, Sharon Bertsch. 2011. The Theory That Would Not Die: How Bayes’ Rule Cracked the Enigma Code, Hunted Down Russian Submarines, and Emerged Triumphant from Two Centuries of Controversy. New Haven, CT: Yale University Press.
- Ibid.