…
Also available as podcast (Episode #108)
Apple | Android | Spotify | Amazon | Audible
What is the difference between reoccurring revenue & fee-based revenue?
“Fee-based” revenue is often “reoccurring” revenue, but “reoccurring” revenue is not necessarily “fee-based” revenue. Confused yet? Often incorrectly used interchangeably, these two phrases can mean entirely different things. Depending on the profile of your practice, it’s a difference that could determine whether your practice is a fit for the RIA model, or not.
Found This Video Helpful?
Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice? I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.
Full Transcript:
What is the difference between “reoccurring” revenue and “fee-based” revenue? That is today’s question on the Transition To RIA question & answer series. It is episode #108.
Hi, I’m Brad Wales with Transition To RIA, where I help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the RIA model.
Again, TransitionToRIA.com.
On today’s episode, we’re going to talk about what is the difference between reoccurring revenues and fee-based revenues.
You might think it’s not that big of a deal, but I wanted to make a quick episode here to clarify because there could be a difference between the two, and it’s worth understanding to make sure you understand how it might apply to your practice.
As a reminder, you’ve heard me say on a lot of episodes, you do not have to be 100% fee only with your practice to potentially transition it to the RIA model. In fact, I don’t know what the exact percentage is, but a big part of the RIA community is not 100% fee only and they accommodate commission assets.
There are several different ways to go about doing it. I’ve done separate episodes on that as well. But the point is, you don’t have to be 100% fee only to move into the RIA. It is part of the conversation to understand, what does your practice look like now? Is there a non fee-based part of the practice and how might we be able to solve for those pieces?
When talking to advisors, early in the first conversation, I usually say, tell me about your practice. Roughly how large is your practice in assets, and then roughly what’s the breakdown percentage-wise between fee-based assets and commission assets.
Sometimes I’ll have an advisor respond and say something perhaps like, “I’m 95% fee-based.” And so by default, that certainly fits the profile to be considering the RIA model. Now, there are other variables involved before you conclude that it is a good fit for your practice, but certainly 95% is within the realm of where it makes sense to be exploring the model.
Anything above 60%, 70% fee-based, it’s worth having the conversation about the RIA model. So, 95% is obviously in that bucket.
But sometimes when I hear a response like that, it’s not clear if it’s really 95% fee-based revenues, or 95% reoccurring revenues. That’s what I’m going to cover on today’s episode, explaining where that could be two different numbers.
What is traditionally thought of as fee-based revenues are your traditional advisory revenue. In most cases this could be where you’re charging an AUM fee on your assets, the typical 1% fee. Or it could be flat fees, subscription fees, retainer fees, etc. These are considered fee based revenue where you are providing advice, providing service, providing value, in return for a fee. Your compensation is not contingent on a transaction occurring where you receive a commission.
These sorts of fee-based revenues require that you are under an RIA to be able to provide those services to the investing public. Whether it’s your own RIA or another RIA that you’re underneath.
Those are the traditional “fee-based” revenues, which in most cases are also reoccurring revenues. The 1% AUM fee is reoccurring. Every year that 1% applies. Obviously, the account value goes up and down. So what that 1% equates to fluctuates alongside that. But it is a reoccurring revenue.
This is what most advisors are thinking of when I ask, how much of your AUM is fee based and how much is commission? They’re thinking of that AUM fee.
Now, I’ll give you two examples of where something is reoccurring, but is not in turn fee-based advisory revenue.
The two biggest examples are variable annuity trails and mutual fund trails.
With variable annuities, it happens often, I talk to advisors that perhaps don’t desire to do new variable annuities going forward – I’ve done episodes on this. If you do want to do that, there are ways you can accommodate that with perhaps an RIA-friendly broker dealer. There are also now fee-based versions of variable annuities.
So I’m not suggesting that you can’t utilize variable annuities in the RIA model, you absolutely can. But oftentimes I’ll be talking to advisors who may no longer want to do new variable annuities going forward, but they are receiving an ongoing trail on their existing variable annuities.
That trail is not an advisory fee. That requires a broker-dealer to be able to receive that ongoing trail. That is technically a commission, just delivered to you on that reoccurring basis.
The other example is regarding mutual funds.
You might have an A-share, or a C-share. Whereas maybe with an A share there may or may not have been a load paid upfront. But with either there is often a 12B-1 trail that is paid on an ongoing basis, perhaps 25 basis points, usually more with a C share.
That is recurring revenue to you as the advisor. You are receiving that month after month, quarter after quarter, year after year. But those trails are not advisory fees, that’s not fee-based fees. That is a commission that is being paid to you in the form of those 12b-1s and it just so happens to be reoccurring. But that requires a broker-dealer.
Receiving variable annuity trails on an ongoing basis and receiving mutual fund trails, the 12b-1 trails, on an ongoing basis requires that you be a registered rep of a broker-dealer because that is a commission that is coming to you.
In the generally accepted language of what fee-based is, you would not put that in the fee-based bucket because the fee-based bucket is generally thought of as what is done as part of an RIA.
If you are in that boat and you have variable annuity trails, you have mutual fund trails, there are ways to accommodate that in the RIA space. Just because you have that doesn’t mean that you shouldn’t explore the RIA model.
You could potentially keep all that exactly as it is by perhaps using an RIA-friendly broker-dealer. Other times it’s worth looking at whether you can “solve” for those assets my moving them into some sort of fee-based arrangement.
An example with mutual funds, whether it’s A shares or C shares is – and maybe there’s reason you haven’t done this previously. Maybe it’s the account size and your current firm won’t let you have fee-based accounts of this size.
But consider, is there any reason you can’t move those A-shares, C-shares into a fee-based advisory account and charge an AUM fee? Once in the account, and this can usually be done on a tax-free basis, is to exchange those shares into an institutional share class.
That’s going to take away the 12B-1 but it’s also going to lower the expense ratio for the client. You then put a commensurate fee on the account that keeps the client neutral on cost. Before, the commission was embedded in the expense ratio, but now you’re (more transparently) bringing the expense ratio down, and adding a commensurate fee.
If mutual fund trails were the extent of your commission assets, and it made sense to do this type of conversion, you could potentially then extract yourself fully from a broker-dealer, fully from FINRA.
Same type of scenario with variable annuities.
There are solutions to potentially convert legacy commission variable annuities into fee-based versions. Now, it of course must make sense for the client.
Perhaps because of when they originally acquired the variable annuity, the interest rates at the time, the riders on the annuity, it would not be an improvement. And so you might need to leave it as-is. There are other ways you might need to explore to solve for those.
But in many instances, because of the market, the interest rates, potentially you can convert those into fee-based versions of variable annuities. And once (if) you do that, again, now you’ve extracted that part of your business out of a broker-dealer.
The main takeaway, and I know this is a fairly short episode, but the main takeaway is as you consider your practice and you consider if you’re a candidate for the RIA model, you do not need to be 100% fee-only. That’s number one.
Number two, as you look at your practice, make sure you’re not mistakenly referring to reoccurring commission revenues, as fee-based revenues. It’s not that that can’t be solved for, not that you can’t find a solution for that, but that is different.
Back to the example I gave at the top. The advisor that says, “I’m 95% fee-based,” might be 60% fee-based, 40% commission. It just so happens to be 35 of that 40 is reoccurring revenue, but it’s commission revenue.
So, I just wanted to make this episode to make sure you understand, to make sure you’re thinking about your practice the correct way.
As I said at the top, my name is Brad Wales with Transition To RIA. This is the kind of conversation I have with advisors all day long. What does your practice look like? Does it make sense for you to be considering the RIA model? What would your practice look like in the model?
Let’s dive into how much of your assets are fee-based and commission-based. And how can we solve for those assets. Very typical conversation I have. I’m happy to have that conversation with you as well.
As a starting point, head to TransitionToRIA.com where you’ll find this entire series in video format, podcast format. I have articles. I have whitepapers. All kinds of things to help you better understand the model.
At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me whether you want to talk about today’s topic or anything else RIA related. I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
And with that, I hope you found value on today’s episode, and I’ll see you on the next one.
Want To Learn More?
Schedule a Discovery call and lets begin a conversation.
