Brooke’s Note: Pity the fellow who has to advise you financial advisors how to be better financial advisors. You have, at one time or another, heard it all — or most of it. What you haven’t heard, you have experienced. Philip Palaveev writes this column knowing he’s that pitiable fellow of the unenviable task. And that may be what gives him a shot at doing for many advisors what hasn’t been done for them before — getting some of that information they know to sink in. Philip offers a glimpse in this column from the pulpit of what may give advisors a better sense of how to learn from the pews. He did a pretty good job of that, too, in his recent book. See: Finally, an RIA business-of-the-business book with a journalistic soul.

I am standing in front of a group of 14 wealth managers who came to our Ensemble Institute in Boulder, Colo. discussing compensation “theory” when somebody asks: “So how do you create a good bonus program for administrative staff?”

It’s a question that comes up so often and is so difficult to answer — and that represents the kind of judgment practice owners have to make. I start answering by going through the “theory” but quickly leave that realm and enter into the realm of “What I have seen is …”

Theory or propaganda?

I begin my answer with the surveys — the measureable empirical evidence. What we know from them is that incentive compensation (bonuses) comprise 5% to 15% of the total compensation of administrative and operations staff. We also know that most advisory firms base their bonuses on the “discretion of the owners” with a secondary factor being the firm’s revenue.

And that See: Wall Street’s big retention problem: RIA compensation is nearing parity with wirehouse brokers where surveys leave us — we know what other firms are doing but we don’t know much about whether or not they find that practice to be effective. We can examine a section of the data to determine what the most profitable firms are doing and try to mimic that but we don’t really know if the profit was the result of the motivational power of the bonus or if the bonus was a byproduct of success by another practice.

Theory often comes to us in the form of recommendations from “experts.” As I stand in front of the audience, I certainly present myself as an expert and I imply that I speak from “theory.” That said, I am also keenly aware of the limitations of my own position and the position of “experts.”

Lessons from tonsils

I once read about an experiment where the researches had the tonsils of 1,000 healthy kids in New York examined by doctors. In about 50% of the cases, the doctors recommended removing of the tonsils. The researchers then took the “healthy” kids to another set of doctors. Again, 50% of the kids received the tonsillitis diagnosis, even though they had already been declared healthy by another doctor (notice the rate is not even dropping). Researchers then took the remaining 250 healthy kids and took them to a third set of doctors. Lo and behold — again 50% of them received the tonsillitis recommendation.

You can see where this is going — go to enough doctors and you will eventually get your tonsils removed. Same is true with consultants — talk to enough consultants and you will eventually get your strategy revised, your compensation plans “fine-tuned” and your processes “optimized.” I do not intend to be cynical or commit business suicide in that statement I just want to recognize my own bias and be keenly aware of it.

Sometimes “practice-management research” is really nothing more than propaganda — it simply promotes the practices that its sponsor would like you to adopt. It also tries to increase awareness of an issue that may or may not exist. Going back to the medical analogy, it is well known that the rate of diagnosis of a disease tends to increase with the invention of a new drug that treats it.

The value of trial and apple

So back to bonuses and the audience. What do I really know? What I know is what I have seen my clients try and succeed or fail at. I have worked with over 1,000 firms in some form over the last 15 years and that library of observations is perhaps my best source of knowledge. It is not theory since I don’t always have a very good explanation of why some things work and some fail but it is my version of the apple that drops from the tree to the ground and I have learned to trust it.

Ultimately, it is a matter of trial and error. The goal of collaboration and sharing ideas is that ideally, you would not have to make all the errors yourself, but learn from others.’ Chess coach Lev Alburt proposes that to be good in chess you need to know 300 common chess positions and how to play them. That is why chess players study games that have been played. That is why advisors should pay attention as much to their own practice as to everyone else’s. See: NAPFA conference yields valuable nuggets of practice-management and marketing advice.

Sharing and judgment

It’s at this point in my talk where the audience comes to life. One of the owners just jumps up and starts telling us what he has done and what works well for him. He tells us that he has tried to use a formula but has never been able to find the perfect one, especially for operations and administrative staff. He says “we tried measuring the number of errors and the number of times they don’t come to work on time and so on but it becomes such a burden to track those things and it creates this 'big brother’ atmosphere.”

That encourages other advisors to share. “We tried that, too, but in the end we decided that there is nothing wrong with us simply evaluating how well an employee does and then letting them know of our evaluation — there is no perfect formula,” says someone.

“Discretion is OK if employees trust you to be fair,” says another advisor. “We use goals setting and simply ask if they completed the goal,” tells us another voice.

Soon we have at least five examples that seem to have been successful. They are not formulas or very theoretical but they seem to have worked well. They mix judgment and trust to create a practical solution where a theoretical one may not be possible.

This is my point — judgment makes all the difference in business decisions and your judgment can be dramatically enhanced by the input of your peers and colleagues. Experience creates judgment but it does not have to be just your experience. Share your experience with others, use the theory with caution and open yourself to input and your decisions will be much better.

The gift of bad calls

In the real world, the data is never clear, the analysis is never complete and “scientific theory” is often ambiguous in guiding your decisions as an owner. Judgment — the ability to choose a direction based on experience and the gut intuition that comes from many such past decisions, is the skill and talent you need the most to be a good CEO. Judgment is a function of what you have been through, your ability to process it correctly and perhaps getting perspective from those who have been where you are going. See: Schwab encourages RIAs to adopt client segmentation but some don’t approve.

“Judgment comes from experience and experience comes from bad judgment,” is one of the adages that is actually true. It perfectly expresses how the best CEOs have developed their skill. Business management theory can help a lot — it helps us frame and properly understand our experiences. It helps us understand what went wrong and what went right and without that understanding we can end up learning the wrong lesson.

“Theory” however can be confusing, ambiguous and sometimes difficult to distinguish from propaganda. The typical standards of scientific inquiry, “empirical,” “ measurable” and “repeatable” are not easily applied to management “science” — while it pursues knowledge in somewhat systematic fashion, it is also a little fuzzy in its methods.

Ultimately, it is the collective experience of peers and colleagues, case studies and benchmarking research that can be tremendously helpful in improving your judgment as a CEO.

Philip Palaveev heads The Ensemble Management Institute is a unique program that guides advisory firms through creating a strategic plan and then implementing it over the course of the next three to four years. The program starts with strategy and then continues through meetings dedicated to human capital and compensation, operations, marketing and sales, financial management and equity management. Each session is held in a small group of non-competing and similar firms which allows participants to learn from each other. The next Ensemble Institute is held in Boulder, CO from May 15 to 17th. For more information visit http://ensemblepractice.com/the-ensemble-management-institute/the-ensemble-management-institute-business-foundations/ or call the Ensemble Practice directly at 206-257-3284.