Ever since the Financial Crisis, wirehouse advisors have been pondering this question as the independent model continues to lure wealth managers from the big banks and brokerage firms. This post discusses the various options that financial advisors (FAs) are faced with today and when it makes sense for them to stick around or do their own thing.
It seems unlikely that English punk rock artist Mick Jones could empathize with future financial advisors when he unleashed his hit single, “Should I stay or Should I go” in 1981. Rather, he was probably referring to his own pending departure from The Clash (though he would later deny that contention). Either way, it seems oddly applicable to many FAs’ current predicament as they contemplate the pros and cons of staying with their current employer or forming their own RIA.
Considerations for Financial Advisors
Perhaps the most obvious consideration is compensation. Though it varies by firm and location, wirehouse firms generally pay out 35% to 55% of fee income to their FAs, with the larger producers typically taking home a bigger cut of the business, according to industry consultant, Michael Kitces. Larger RIA firms, on the other hand, tend to pay their FAs 40% to 50% of fee income, 20% to 30% in non-compensatory overhead costs with the residual 20% to 30% in profits, depending again on size and location and dozens of other factors. This means that a solo practitioner could earn as much as 80% of his or her fees by starting their own firm, collecting all the fee income net of overhead expenses.
Based on this math alone, it’s hard to comprehend why over 50,000 advisors and $7 trillion assets have remained at Bank of America Merrill Lynch, UBS, Morgan Stanley, and Wells Fargo alone, according to the InvestmentNews Advisers on the Move database. IN attributes this phenomenon to signing bonuses at the wirehouse firms, the security they offer, increasingly higher compensation packages for top producers, and appealing retirement deals for senior FAs looking to cash out. Or it may be that capturing that margin for oneself is easier said than done.
Kitces contends that “end advisors are often able to keep 10% to 20% more of their gross revenue after making the switch” even after considering all the perquisites that the bulge bracket firms are offering. So from a sheer economics perspective, it appears that going independent makes more sense, but there are still other factors to keep in mind. For one, you have to get client consent, which is not always a given, especially if the client identifies more with the bank than the broker, which is often the case with elderly investors. You’ll also have to invest time and money in technology, personnel, and other overhead charges that were previously provided by the brokerage firms. In addition, you’ll be suddenly responsible for practice management unless you pay someone else to do that for you, which can also be costly. Indeed, if you go, there could be trouble, as Mick Jones warned us.
Don’t leave without first thinking about your employment agreements, non-compete agreements, non-solicitation agreements, etc. The only thing worse than starting a business with plenty of overhead and no clients is starting a business with plenty of overhead, a few clients, and a lawsuit from your former firm.
The obvious advantage of staying with a wirehouse is the plug-and-play platform that allows financial advisors to concentrate on client service and selling, rather than running a business. We hear plenty of grumbling about the big firms being run by lawyers instead of business development staff, spending so much time on defense that there’s no time left for offense.
Compliance issues are rising in the independent RIA space as well, though, and when you’re in charge of your RIA, you’re also in charge of the compliance department. Oddly enough, at the same time brokers are weighing leaving big banks to go out on their own so they aren’t constrained by back-office regulations, independent RIAs are consolidating to allow their top people to focus on clients instead of practice management.
There are plenty of tradeoffs to being independent. But staying could be even more problematic. The independent model allows you to better take advantage of the inherent operating leverage of the asset manager business. Rather than earning a fixed percentage of the fee income from client assets, an independent RIA owner/operator can achieve significant levels of profitability to augment fee income by growing AUM with more modest increases to overhead expenses. We’ve seen larger wealth management firms (client assets over $500 million) achieve EBITDA margins of 25% or greater when overhead costs remain relatively contained. Potential returns do appear to be commensurate with the risk involved in most of these situations – which is, after all, kind of the theme of investment management.
Mick Jones ultimately decided to go, and has enjoyed something of a post-Clash career (although you could be forgiven for not being able to name any songs by Big Audio Dynamite). If you’re considering going independent, we just hope you keep this all in mind.
Upcoming Webinar: What Is My RIA Worth?
Our most popular blog topic concerns the actual worth of investment management firms. As such, we thought it would be worthwhile to offer a webinar on the topic, and are planning to do so on Tuesday, October 3 from noon – 1:00pm (CST).
In the webinar, What Is My RIA Worth?, we will cover certain core issues such as:
- How to normalize cash flow to determine the profitability of a RIA
- How to compare different investment management firms to determine what risk-adjusted valuation multiples to apply
- How to evaluate the growth potential of one firm relative to the industry or relative to other firms
- What public company multiples say about how a private RIA is valued
- Are industry transaction multiples a useful benchmark in valuing an investment management firm?
The webinar is free to partners and staff of investment management firms. You can find out more information and register below.