The Power of Compounding – For IFAs

01 Dec 2016

Einstein observed: “Compounding is the eighth wonder of the world.” As financial advisors, we quote this to our clients almost every day. Beyond a doubt, compounding adds tremendous value to investments over time. Though financial advisors understand the importance of compounding, they relate it mostly to client’s investments only. They miss another important characteristic of compounding; “Compounding works almost in every field.”

When we exercise for a day, we actually feel pain and fatigue. When we exercise regularly, the effort compounds and we can see the benefits in the transformation of the body. Similarly, when players practice a sport regularly it compounds over a period of time and they become unbeatable. There are endless examples of the power of compounding. An important point to note is that, compounding gives best result over long periods of time.

I want to coin the idea of “compounding of trust” in the profession of financial advisory.

The financial advisory profession is essentially a business of trust. The more the clients trust us, the more business we get. How is trust created?” By doing the right thing over and over again we become trustworthy. Each time when we act in the interest of clients, it adds up. It compounds. Over years and decades this trust becomes rock solid and forms a solid platform for enormous growth.

The way advisors suggests clients to invest for long term to create wealth (because compounding doesn’t work in a year or two), in the same way advisors should keep on building trust with clients over long term, typically 15-20 years. Once they do, they can expect to reap substantial rewards. Many advisors work very hard but fail to create trust with clients. They do reasonably well in the short term but struggle to grow in the long term.

Growth comes from growth of clients

The profession of financial advisory is pretty simple. The growth of a financial advisor is largely dependent on the growth of her clients. Suppose, in a few years of starting, an advisor creates a base of 200 clients. Over time few clients will become inactive or leave. Few clients will remain small. A lot of clients will grow at an average speed. However, a few clients will become extremely wealthy. They will possess huge investment capability and it is this set of wealthy clients who will become the basis of growth of an advisor. Since trust is established, many of these wealthy clients will stick to their financial advisor and their portfolio will soar high. They may be just 10% of the initial 200 clients, but they may contribute 90% of the advisors assets under management. That’s the way it has happened for most of the top advisors in India today. That’s the way it will happen for others too.

It won’t happen in a year or two. It will take a decade or two and an advisor needs to be patient for such long period and keep on doing the right thing over and over again. No matter what regulatory changes happen in the future, if the client has irrevocable trust on advisor, revenue generation by advisor won’t be an issue.

Summing up

Build trust with client. It compounds over time. Clients pay a huge premium to trust. Advise clients to take advantage of compounding of investments. As an advisor, we should build our business by ‘compounding of trust’.

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