Q72 – How To Calculate Your True “Net” Broker/Dealer Payout?

Also available as podcast (Episode #72)

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How To Calculate Your True “Net” Broker/Dealer Payout?

I am frequently asked how the economics of the Registered Investment Advisor (“RIA”) model compare to the broker/dealer model.  The first step in a comparison is to calculate your existing broker/dealer payout.  However, you can’t simply refer to a payout grid table, and conclude that is your payout.  There is a reason advisor compensation plans generally run 20+ pages!  What eventually flows to your pocket, is often far different from what the grid table would indicate.

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Full Transcript:

How to calculate your true net payout. That is today’s question on the Transition To RIA question & answer series. It is episode #72.

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 to the RIA model.

If you’re not already there, head to TransitionToRIA.com, you can 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.

And again, for you podcast fans, if you are watching this in video format and would prefer podcast, you can search for the “Transition To RIA Podcast” on all major podcasting platforms.

On today’s episode, we’re going to talk about your true payout of where you are currently and how that compares to the RIA model.

A common conversation I have with advisors that are considering the RIA model is understanding the economics. What are the advisor’s current economics, and how does it compare to the economics of the RIA model?

I will ask an advisor or team what their payout is currently. The responses I get back are what prompted me to make this episode. Advisors often are not fully appreciating what their true net payout is, and they’re simply quoting how their firm has positioned it.

I’ll give you two examples.

A wirehouse (W2 model) advisor will often quote solely a figure from the payout grid.  Maybe a 42% payout. That’s the only thing they’ll mention.

The compensation plans at these firms usually run 20+ pages. It’s not just that little grid table. If all you do is quote that chart and you look past all the ways those 20+ pages work to whittle that number down, you’re not fully considering your true payout.

Different firms monkey with the payout in different ways.  With some, you don’t receive a payout on your first $4,000 in production each month. Or you don’t receive a payout on certain size accounts. Or if you don’t make enough referrals to the banking channel, you’re penalized a point or two.

When you want to talk about your true payout in the W2 model, you can’t just quote the grid table? It’s what does the grid say, but also what is the figure after the various gimmicks in the compensation plan are applied.

In the independent broker-dealer model, I equally often hear just a grid number quoted. It might be a seemingly generous figure like 92%.  That’s usually all the advisor mentions.

I then inquire if the advisor is paying (firms use different names for it) some sort of platform fee or advisory fee? Usually expressed in basis points. The answer is usually along the lines of “Yes, there’s a 20 basis point platform fee.”  Usually followed by a quick rebuttal of, “but the client pays that.”

Point being, there is usually always more to it than just what the grid table says.

When you want to calculate your true net payout, consider what is the total fee the client is paying, and how much of that reaches you.

I’ll give an example using simple numbers. Let’s say you are affiliated with an independent broker-dealer. The fee for the services that you provide is 1%. Of that 1%, you get a 90%, “payout”, that is what you retain. The firm also charges the client a 20 basis point “platform fee”, which you receive none of. So, in total, the client is paying 1.2%.

The client doesn’t care who is getting paid what behind the scenes. The client considers what they are paying in total, and what value and services are provided in return.

In this example, the client is paying 1.2%, however you are only receiving 0.9%. When you run that math, 90 cents on a $1.20, that 90% “payout” is now only a 75% payout. That’s not nearly as generous as it originally seemed.

Firms in part try to position it as a “90%” payout, because they know they’ll be compared against other broker-dealers, who are using a similar gimmick. So they need to appear competitive.  But the 90%, 92%, or whatever, is irrelevant if you’re not also going to factor in the additional fees that are being charged. Consider the total fee the client is paying, and how much of that flows to you.

One caveat to this example, is it does not involve an asset management solution. If you want to use a managed solution, there is typically an additional fee for that as well.  Which is far, as there is an additional service being provided as well.  Regardless, you’ll want to run the same exercise of what is the total aggregate fee the client is paying, how much of that flows to me? In the RIA model, there are ways to potentially reduce the cost of the investment management piece as well.

I encourage you run this exercise and calculate your true net payout.

Next, how does that compare to how your economics would look in the RIA model?

There are several pathways into the RIA model, many of which I have made separate episodes about (ex:  Supported Independence.)

One pathway is to start your own RIA. With that approach, 100% of the fee that you charge the client for your services comes to you. Not 90%, not 40%, 100% comes to you.

Now, to be fair, you have expenses that you need to pay from this, so I’m not implying that 100% flows to your bottom line. But 100% of the fee comes to you initially.

Let’s go back to my example of the client paying 1.2%. That was your advisor fee, plus a platform fee.  For simplicity, I won’t involve an investment management solution in the example.

There’s no reason you can’t continue to charge your client 1.2% in the RIA space. Your client is currently paying 1.2% (in aggregate), and you are providing value and services in return for that 1.2%. As they’re remaining your client, they are presumably satisfied with the value they are receiving. If you move into the RIA model and you maintain that 1.2% fee, 100% of that goes to you.

“Payout” terminology is not applicable when you have your own RIA. While the custodian might facilitate the deductions of the fees from client’s accounts and remit it to you, it does not go through their P&L. It’s does not go through any sort of payout grid. It’s 100% your fee. It’s remitted to you, and you then cover your costs, and you run your own P&L.

The other main pathway into the RIA model is to join an existing RIA.

These firms bundle and provide you with the necessary components of running an advisory practice. (As opposed to when you start your own RIA, you might need to compile the pieces yourself.) In return, they charge a fee for their services.

Some firms express their fee as a “payout”, while most do the inverse and express it in bps or a % of revenue charge. They provide you with services such as compliance, technology, marketing support, E&O coverage, etc. They bundle it up and charge you a single fee.  An example might be ~20bps.

I think this is how all firms should do it. Expressing the cost as an inverse of the “payout” makes it easier to quantify the total cost. You then compare that cost to the value you are receiving in return.

Consider the example of a W2 advisor generating $1 million in total fees and commissions per year. For simplicity sake, we’ll assume they have a “payout” of 40%. Which based on everything I’ve been discussing, it is not really 40%, it is less. But for this example, we’ll assume it somehow stays exactly 40%.

This advisor is therefore receiving $400,000 (40%.) The inverse is their firm is retaining $600,000 (60%.) The question is, is the advisor getting good value for the $600,000 they are paying their firm each year?

This is how you want to consider a payout. Not just what your true net payout is, but also what is the inverse? How much are you paying, and what you are provided with in return?

If at a W2 firm, you are likely being provided with an office, maybe support team members, benefits, technology, etc. There are hard costs associated with your firm providing you with those resources, and they need to cover that expense. As a for-profit company, they also deserve to make a profit. The question is, though, is it reasonable what they are charging for the value you get in return?

The larger you grow your practice, the more painful that math becomes. Some advisors and teams are paying their firms millions of dollars every year.  Are they getting millions of dollars of office space, millions of dollars of technology, millions of dollars of compliance support? This is where the math becomes very inconvenient for a lot of broker-dealers.

I went off track there, but the main point is to consider not just your true net payout, but also the inverse of it as well.

Again, though, I don’t want to give the impression that the RIA model only involves getting a 100% “payout”.  You do have expenses you in turn need to cover yourself. But to be sure, if you start your own RIA, 100% of the fee you charge your client comes to you.

And if you join an RIA, it’s either a payout or typically some sort of inverse figure expressed in either percent of revenue or basis points.

The main key is to consider how much of the fee being charged the client flows to you. Whether you have a 20+ page comp plan, or additional “platform fees”, or whatever the case is, you need to work through this math to be able to make an apples-to-apples comparison with the RIA model.

As I noted, in the RIA model you do have “local expenses” you need to pay for yourself. It’s worth asking though, how much bottom line income could I expect to receive after I cover those expenses?

When answering this I’ll often refer to a scenario of a reasonably sized, reasonably run firm.

With respect to size, the RIA model is a scale game. If you’re too small, the math does not work as well. Regarding reasonably run, you get to control your own local expenses. If you want an extravagant office, that’s fine. You can do that, that’s going to cost more. You have control over your cost structure. Every advisor or team manages things differently.

If reasonably sized, and reasonably run, a typical RIA nets in the range of 60% to 70% of top-line revenue, before the owners pay themselves. That’s effectively your net payout if comparing to a W2 model.

Remember, the first step is making sure you are calculating your current net payout correctly. If you’re simply quoting something like 92% (independent broker/dealer) or 45% (W2), you’re not considering the whole picture. You need to go through the exercise of factoring in all the gimmicks, all the different fees, after covering your local expenses, and then what flows into your pocket at the end of the day. That’s the most important thing if you want to do an apples-to-apples comparison.

Another important takeaway is this isn’t just about numbers. I don’t want to imply that the RIA model is automatically superior because 60%-70% is higher than maybe the 40% at the wirehouse firm. That would be like a client coming to you and saying, “Your fee is 1%. There’s an advisor down the street that will help me for 0.8%. So apparently, I should go with that other advisor because they charge a lower fee.”

Fee alone is not the whole picture. The value received in return for the fee is what is important.

As I spoke about earlier, figure out what the inverse is of your payout.  What are you paying your current firm each year? Are you getting good value for what you’re paying? If you’re paying your firm $600,000, are you receiving $600,000 worth of value every year? If so, you might be in an arrangement that works well for you from an economic standpoint. (This is not getting into other factors like flexibility.)

If you’re not getting good value, ask yourself if you could replicate those same services you’re being provided, at a lower cost than you’re paying now?  And usually with more flexibility and choice.

That savings, that delta, is where the better economics of the RIA model come into play. Where more income can flow into your pocket at the end of the day.

But again, I don’t want to harp on just numbers alone. You must consider, “what value am I receiving for the amount I’m paying?” And then make a true apples-to-apples comparison to how the math would look with another affiliation model, such as the RIA model.

The final takeaway is the importance of investing the time needed to better understand the RIA model, and how the economics work.

Advisors continue to migrate to the RIA model for good reason. But you need to understand what it would look like for your specific practice. There are several reasons advisors are motivated to move to the RIA model that don’t have anything to do with economics. Those are important to understand as well.

Understanding how your practice would look in the RIA model is what I help advisors with.  What is your current payout and cost structure?  What services are you currently providing your clients? What is your vision for your practice going forward? What would your economics look like in the RIA model?

It never hurts to be fully informed of how the RIA model works, so you can compare it to what you have now. I’m happy to have that conversation with you.

The first thing to do is head to TransitionToRIA.com. Again, you can find all my videos, podcasts, articles, whitepapers, all kinds of resources to help you better understand the RIA model.

The most effective step though is to reach out to me for a one-on-one conversation. At the top of every page is a contact link. Click on that and you can instantly and easily schedule a one-on-one conversation. We can dive into today’s topic or anything else RIA-related you would like to discuss.

Again, TransitionToRIA.com.

With that, I hope you found value in today’s episode, and I’ll see you on the next one.

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