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How to choose a custodian for your RIA?

Selecting a custodian, or in some cases more than one custodian, is one of the most important decisions you will need to make as you transition into the Registered Investment Advisor (“RIA”) model.  There are multiple “table stakes” variables that you should expect to be present by default with any potential custodial provider.  From there, custodians generally work to differentiate themselves from the competition by either the clientele they seek to attract and/or the unique services they provide as part of their value proposition.  Wrapped on top of all of this is what pricing the custodian in turn charges for these services.  Ultimately, what might make for a good custodial partner for one RIA, might be the exact opposite for another.

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Full Transcript:

How to choose a custodian for your RIA? That is question #53 on the Transition To RIA Question and Answer series.

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.

Today’s question, we’re going to talk about if you move into the RIA model, how do you choose a custodian to use – or in some cases, which we’ll get into – custodians, plural, to use with your new RIA path?

You might recall from previous episodes, and I’ll make sure to link them in the show notes, there’s three main ways into the RIA model. And because I’ve gone into them in-depth, I’ll go real high level here.

The three main ways into the model are, first, start your own RIA and build out your necessary solution providers around you. One of those solution providers would be a custodian.

On the other end of the spectrum is to join an existing RIA platform that’s already built out that infrastructure for you. And then there’s kind of a go-between option there in the middle, which is where you can still have your own RIA and outsource a lot of the middle and back-office functions of running the day-to-day of the RIA.

No matter which of those paths you go down, though, you will need at least one custodian, sometimes more.

Now, I guess I should point out, there are some narrow circumstances where you wouldn’t need a custodian and that is solely for a practice that is, as they say, provides fee-for-service only. That might be what your value proposition is to provide, solely advice. Maybe it’s financial planning advice, and you do so on an hourly basis, or maybe a monthly subscription basis. But you don’t actually take control of the assets to manage yourself. You rely on the investor, the client to do that elsewhere. And so, in that case, you would not need a custodian.

But in most of the traditional models, where part of your value proposition is to manage the money, you will need at least one custodian, possibly more than one custodian.

Again, and no matter which of those paths you go down, starting your own, joining an existing firm, or using a middle office provider, you will need a custodian regardless.

What I’m going to talk about in this episode are some of the variables that go into helping you figure out which custodian or custodians to utilize. This is the kind of conversation I have with advisors all day long. Helping them figure this out and figure out which one might be a better fit than others.

What we’re going to go over here today is at a macro level. Each situation is unique, each advisor, each team, and so this won’t cover every imaginable scenario, but it will give you initial guidance on it.

To start with, there’s a certain amount of, we’ll call them table stakes that any of the major custodians provide. The reason I call them table stakes is because they are not a differentiator amongst the choices of custodians out there. They’re essentially must-haves. They’re things that you will expect from your custodian no matter which custodian you might select. And because of that, again, it’s not a differentiator for them, it’s not how they position their value proposition.

I will separately get into what those differentiators are when they do occur. But I want to run through a couple of table stakes to keep in mind.

As an example, all of the major custodial options have massive scale. The custodial game is a very low-margin, high-scale business. It only works when the custodians have massive scale – tens, hundreds of billions, sometimes trillions of dollars on their platform – because, again, it’s a very low margin.

With that scale, they’re able to provide their service for a reasonable fee. Any of the main choices you might look at, they all have that scale, otherwise, they wouldn’t be able to compete in the marketplace. So that alone is not a differentiator by any means.

Custodians are also well-capitalized. The reason I point this out is one of the main reasons you want to have a custodian – besides you needing them to provide custody and clearing of your client’s assets – is you want your clients to feel comfortable about where their assets are being held.

You don’t want some company that is possibly on the verge of being illiquid and going under, and the associated consequences that will have for clients in trying to retrieve their assets.

Any of the major options out there are very well-capitalized. That is in part why you are leaning on them to provide the role of custody and clearing for your client’s assets is because of the soundness of their business. And so, again, not a differentiator, that is table stakes just to show up at the game.

The next table stakes is investment product availability. What I mean by that is all the major custodians are going to offer pretty much every equity, ETF, mutual fund, fixed income, option, those sorts of things. There is some slight variation – I did a whole episode, for instance, on mutual fund availability at one custodian versus another.

So, there is some degree of variability and that’s part of your due diligence of a custodian is to make sure that they can accommodate all of the solutions you’re currently using with your clients, or at least that you want to continue to utilize with your clients.

It’s worth pointing out there’s variability, but across the board – I’ll just throw a number out there – 98% of whatever you’re using currently is most likely already available at the custodian. Sometimes that could get a little tricky if you are using certain money managers.

That’s a whole different conversation because there’s multiple different ways to access money managers through TAMPs and whatnot. So, I won’t dive into that in this episode. But the main point being it’s not a differentiator. They all offer thousands of mutual funds and ETFs and equities and all those sorts of things across the board.

Next is transition support. The custodians will all tell you they offer wonderful transition support to help you move your assets to them. It is fair to say they do dedicate a lot of resources into providing a good transition experience. You could argue some firms are more robust in some areas than others and that is something maybe to take into consideration. But they absolutely all provide a degree of transition support.

I should have prefaced this. When I say “transition support” I’m not meaning, “Hey, here’s money, here’s an upfront check,” or anything like that. I’m referring to the resources, the personnel, the time they will commit – oftentimes, coming out on-site to help you in those first couple of weeks of moving your client assets over.

This is an important part of the process and you want good resources. They all provide transition support services because they need you to be a successful client of theirs to bring your clients with you. So, they have a vested interest in doing everything they can to help you move the assets as well.

Finally, some random things like lending capabilities. If you use margin in some of your clients’ accounts, that’s table stakes. Custodians actually love that. I did a whole episode on how custodians generate revenue.

Margin or non-purpose (aka securities-based) lending, absolutely are available because again, that is one of the primary ways that a custodian generates revenue. Again, I did a whole episode on that topic alone if you want to dive further.  (Editorial note:  I’ve also done an episode on how broker/dealers generate revenue.)

The main idea is you can expect these table stakes no matter which of the firms you look at. You expect them to be there, they need to be there, but they’re not going to be a massive differentiator between one firm to the next.

The question therefore is, what are some of those differentiators? I want to go through that now. This is in no particular order.

First, each custodian potentially has a minimum amount of assets that you need to commit to moving to them and realistically be able to deliver on to use them as a custodian. Now, that ranges. Some custodians have a $0 minimum, and others start in the $100 million-plus range.

If you can’t show that you currently have $100 million or show the pathway where that would quickly be achieved, they are not going to be a custodial solution for you.

You might be asking…”Why would I want a firm that has a high minimum when there are firms that have no minimums?”

There are different opinions on that. Firms that have higher minimums would tell you (accurately) that they are trying to attract a particular size advisor. And because that’s all they will partner with, they can put all of their time and resources into the support and services those type of advisors need. They can stay focused on that particular slice of the advisor community.

They might critique the custodians that will work with RIAs of any size by saying…”They are spreading themselves too thin and they are trying to be everything to everyone. And if that’s the case, you’re everything to no one.”

That’s probably a harsh argument to make because again, these firms have massive scale, so they can dedicate a lot of resources to different size relationships along the way.

But I think there is some truth to saying that if they are focused on a particular advisor profile, they can dedicate more resources accordingly.

So, just something to be aware of. Depending on your size, some custodians will literally not even be an option for you, whereas others certainly will be available.

The next differentiator to be aware of is what the value proposition is of the custodian at a macro level.

There are some custodians that their value proposition is to say…”Mr. and Mrs. Advisor, you go start an RIA, you come use our solution as we have a fully integrated solution. We have all of the technology you need, we have a TAMP solution, we have a fee billing solution, we have everything you need integrated seamlessly into our offering. It is the proverbial ‘plug and play’ and off you go.”

Now you might think…”Wow, that’s fantastic. Why would I not want that?” I’ll circle back to some instances where that can be a good thing and where maybe it’s not a good thing.

Then on the other end of the spectrum, you have some custodians that say…”As opposed to using our capital to try and build out our own technology, we would rather spend our resources integrating with all of these wonderful, innovative, third-party technology solutions that are always improving their own product. As opposed to trying to compete with that, we’d rather let them compete to provide you with the best solutions. Instead, we are going to dedicate ourselves to making sure we can integrate properly and successfully with each of those third party solutions.”

Is one of these approaches better than the other? Not necessarily. It matters what you ultimately want to do with your RIA.

An example of where an integrated solution could be a challenge is if at some point in the future you desire/need to be multi-custodial with your RIA. I did a whole episode on the differences between single custodian or multi-custodian.

If your primary custodian is an integrated solution, and you’re using all of their technology and their TAMP solution, and then at some point in the future you need or want to add another custodian, the technology and the TAMP and whatnot from the integrated solution is not going to work with that other custodian.

You will now need to use a separate tech stack or a separate TAMP solution for when you open accounts at that other custodian. There’s a school of thought that says if there’s a chance you are going to be multi-custodial either initially or at some point in the future, that you want to separate the technology, separate the TAMP, separate those sorts of things from the custodian so that you can work with multiple custodians from the same tech/TAMP stack. That is part of what I help folks with is building all of that out.

The idea is if you have an independent third party tech stack, TAMP solution, then you can add custodians, and it’s not going to cause you to have one set of processes for some clients versus another set for other clients.

To the degree you feel you will only ever need to be single-custodian, there are some wonderful integrated solutions that might be a great fit for you. To the degree you think you might at some point be multi-custodial, you need to be considering whether an integrated or more third-party approach to some of these solutions is a better path for you.

Next differentiator is a custodian’s ability to accommodate a hybrid solution.

I’ve done a couple of episodes on this, how you have the option of going down the RIA model route – either starting your own RIA or being under another RIA – and still be able to accommodate commission business.

The way that is generally done is to utilize, as they say, an “RIA-friendly broker-dealer” that accommodates your commission business. Again, I’ve done a whole episode on that, a deeper dive. Take a look at that.

Important to know is with which of those RIA-friendly broker-dealer solutions you use, some are more efficient to use with certain custodians than others. Where you put your advisory assets will in part steer which kind of RIA-friendly broker-dealer you want to utilize or potentially vice versa.

You might find an RIA-friendly broker-dealer that’s a very good fit for you and because of where they themselves custody assets or who they are integrated with, that that will help guide your custodian selection as well.

I’m not pointing this out to complicate the process or make this sound intimidating – because this is something I help advisors with daily is thinking through these variables – but just know to the degree you are going to need or want some sort of commission solution for your practice, that will be relevant in your custodian selection decision.

Next up is pricing, which is an important topic.

As part of your due diligence on any custodian, you will want to know what the pricing will look like. Will I be charged transaction-based fees for my clients? Will I be charged a custodial fee, sometimes called asset-based pricing? Will there be other fees involved?

And over the last couple of years there’s been a big movement towards no transaction charges.

In some instances, with some custodians, there is no transaction charges on certain kinds of trades. That might be equities or ETFs. And in many instances, but not all, mutual funds. I did a whole episode on the latter, regarding no-transaction-fee (NTF) mutual funds that explains that.

Depending on the custodian you use, there might be no transaction fees, but not necessarily on every investment product you might look to use.

As you compare custodial options, you want to look at the pricing one will charge versus another. There are no rack rates across the board. Each custodian will look at what you are able to bring to them from an AUM perspective, from the kind of clients you’re going to bring to them, maybe you’re going to use lending solutions, those sorts of things. They will provide you pricing to your specific situation.  That is an important part of custodial selection.

Don’t however default or assume that the custodian that has the lowest “pricing” is necessarily the best solution for you, and more importantly, your clients.

Oftentimes, a custodian that is cheapest for the RIA is not necessarily cheapest, or arguably best for your clients. One of the ways that custodians have enabled some of the transaction pricing to go down to zero is by limiting, for instance, your options on where cash in your client’s accounts sweeps to.

Right now, with interest rates so low, it’s not really an issue. But under a more normal interest rate environment, that could have a meaningful difference for your clients.

The better trade-off might be, pay nominal transaction fees, but as a result, your clients’ cash will sweep to a more favorable sweep option. The amount of additional interest your clients will generate might easily exceed the transaction charges. That variable is important to weigh into your decision.

So, again, just keep in mind, there’s what is the pricing for the RIA? And then what does that look like for your clients? You’ll want to take both of those into consideration as you consider custodians.

Next is technology.

I already covered this when we talked about an integrated solution versus using third-party solutions. But just be aware, there’s essentially three flavors to this.

Some custodians present what they feel is everything you need from a technology stack perspective.  A fully integrated “plug and play” solution.

On the other end of the spectrum, some custodians say…”We don’t attempt to build out our own technology because we’d rather rely on these wonderful folks out in the marketplace creating all kinds of solutions. We instead focus on integrating with those solutions.”

Then you have kind of a middle ground where some lean heavily on third-party integrations but also provide some technology that is optional, but not required that you use it.

So, different flavors on technology.

The last point is whether your custodian is a B2C (business to consumer) or a B2B (business to business) custodian. The term often used in our industry for this is “retail channel conflict.”

There are some custodians that provide wonderful custodial services for RIAs, but alongside that, they also cater directly to clients in the marketplace themselves as well.  They are advertising to clients saying…”Come open an account directly with us.”  Which is increasingly including direct advisory services. Effectively you’re competing against your custodian for clients in the marketplace.

There are other custodians that are solely a B2B, business to business play that do not at all open accounts directly with individual retail clients. They say… “We only cater to institutions. RIAs, banks, trust companies, those sorts of things. We are a B2B play, we do not compete with our RIA clients. We feel that is the best experience for all parties involved.”

So, which approach is better than the other? Like anything, there are pros and cons to each.

The firms that also have retail channels would rightfully point out that because of those hundreds of billions of assets of retail clients, they have more scale and more resources to reinvest back into the platform, which then their RIA partners benefit from.

Likewise, the B2B folks would say…”Yes, this is a scale game. But we’re already huge. We already have trillions of dollars in assets. Every incremental dollar of assets would be nice, but it’s not due to a lack of capital of what we can do with our platform. We’d rather build it out as best we can and not be in competition with our RIA clients.”

Again, pros and cons to everything. It’s not to say one approach is always better than the other.

I’ve had plenty of conversations where some advisors say…”You know what, I’m not worried about that at all, I don’t even care, my clients aren’t going to care.”

Then you have other advisors that feel…”I don’t want my custodian in conflict with me, and I do think it’s going to be an issue.”

It’s wonderful that you have these choices in the marketplace.  You can use the approach you feel is best for your specific circumstances.

The idea with all this is to be aware that there are a lot of variables that go into choosing a custodian. Some are table stakes, you can expect them, you don’t need to spend much time on them, they’re going to be there for you.

Then with the differentiators, you want to understand them, understand what you would be satisfied with, and which custodians check which of the boxes. That’s a big part of what I do is help advisors both understand the whole RIA / custodial relationship – understand why they might want to be single versus multi custodial, those sorts of things – and then really get in the weeds.

Based on your specific needs, your client profile, your goals for the future, here are the custodians that are going to be a better fit for you than others. And other times, another advisor might be the exact opposite. It’s working through each of the variables one by one.

With that, like I said, my name is Brad Wales with Transition To RIA. Today’s episode is a wonderful example of the exact sort of thing I help advisors think through.

How does this work at a macro level? How does the RIA custodial relationship work? And then working through all these details to find the best solutions for each advisor based on their specific circumstances.

I’d be happy to have that same conversation with you.

If you’re not already there, head on over to TransitionToRIA.com. On there, you can find all of my episodes. I have videos, podcasts, whitepapers, and then at the top of every page is a contact link.

If you click on that, you can instantly and easily schedule time to have a one on one conversation with me to dive immediately into this topic.

In most cases, that conversation starts with…“Help me understand what this RIA option looks like. Is this even something I should be exploring?” And then to the degree that it might make sense, we start peeling back the onion and start going through these layers and figuring out all the options and all the decisions that would go into this.

I’m happy to have that conversation with you.

For now though, I hope you found value in today’s episode and I’ll see you on the next one.

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