Q69 – How To Generate The Highest Income With Your RIA?

Also available as podcast (Episode #69)

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How To Generate The Highest Income With Your RIA?

To increase the income of any business, you need to either increase revenues or decrease expenses.  Preferably, you do both.  The RIA model is no different.  In this episode, I discuss two ways to increase the revenues of an RIA, and three ways to decrease expenses.  While not an exhaustive list of ways to expand profitability, these strategies are available to any advisor already in the RIA model, or those mapping out an eventual transition to it.

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Full Transcript:

How to generate the highest income with your RIA? That is today’s question on the Transition To RIA question and answer series, it is episode #69.

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, where you can find all of the resources I make available. From the video series, podcast series, I have articles, I have whitepapers, all kinds of resources there for the taking.

I noted the podcast, if you are watching this on video and you prefer podcast format, search for the “Transition To RIA Podcast” on all major podcasting platforms, you can find that as well.

Again, TransitionToRIA.com has all of the resources.

Today’s episode applies whether you already have your own RIA or you are thinking about transitioning to become your own RIA and you’re mapping out what the future structure of your firm is going to look like.

The question is, how can I generate the highest income with an RIA? That’s what we’re going to be talking about on today’s episode.

I have five topics I want to go over. This is not going to be an exhaustive list of any and every way you possibly could manage an RIA. There’s plenty of practice management experts out there that will get much further in the weeds on some of these topics than I will here.

But I do want to talk about five things. Whether you have your RIA and you’re trying to refine your process now, or – which is a lot of my audience – you are thinking about becoming an RIA, it’s much easier to build things from the start with some of these things in mind. Again, of how to generate the highest amount of income for your RIA.

At a high level, if our goal is to increase income, that can be defined two different ways. The total dollar amount of income we’re trying to increase, and/or the profit margin for every dollar of revenue that comes in. How much of that flows to the bottom line of income that we’re trying to increase. And ideally, you pursue both.

How can we have the maximum profit margin we can, and how do we increase the size of the pie as well so that bottom line dollar amount will increase as well? That’s the focus of this episode.

If we’re going to increase income, we must do one of two things, and ideally both. We must increase revenues somehow, so I’m going to touch on a few topics there. And/or we must decrease expenses in some fashion. I’ll touch on a couple of topics there as well.

First, we’ll jump into increasing revenue. There are two topics I want to talk about on today’s episode regarding this. Again, this is not an exhaustive list of all the ways you could grow your firm. These are some of the more unconventional things that people don’t often think about that are important to be able to grow your revenues. Which, again, that’s a big part of the equation to increase in profits is to grow your revenue.

The first one is to outsource where you can. As you look at your practice or your future practice, ask yourself what are the non-client facing, or non-value adding tasks that must be done? There are tasks that must be done that your client likely doesn’t perceive as some sort of value add because they’re happening in the background. Perhaps it’s an operational task, which your client maybe doesn’t even realize is occurring, but it is a necessary part of running your own firm.

Of those tasks, can you outsource them to someone else that can do it better for you, and ideally cheaper as well?

You might be thinking, “I don’t mind doing some of these things tasks myself or I can have my team members do them.” But the reality is there are a lot of commoditized parts of running a modern-day advisory firm. A lot that is not client-facing, is not arguably value add to the client. It’s value-add to you, you need those tasks to keep the lights on, keep the firm running. But because they’re commoditized, your efforts, your team’s efforts are not really doing it better, arguably, than someone else could do if you were to outsource it to them, on your behalf.

When you outsource, it frees up your time to spend more time on business development efforts, spend more time on working with existing clients, which will hopefully lead to more referrals.

If it’s you or your team and you’re not adding value to the client directly or value that they perceive, you’re better off outsourcing that. I’ll get into how that is done in a moment.

You might be thinking, “If I outsource, I have to pay someone to do it. Is that going to be more expensive than me just doing it myself?”

An example is, let’s say you have a million dollars in fee revenue coming in, that’s the size of your practice. And because of how you’ve structured it you’re getting 70% margins from that top line. You might think, “If I outsource, I will have to pay someone to do the tasks.” But the reality is, if you outsource, that frees up your time to grow your firm, and won’t you be better off even if your profit margins are lower?

With our example, you’re generating a million in fee revenue now and getting a 70% margin. What would you rather have? That scenario or would you rather have a $2 million firm that gets 60% margins?

Your profit margins might decline, but it can enable your firm to grow faster because you can spend more time on business development, fostering existing relationships, looking for referrals, etc.

Is it not better to have a $2 million firm with 60% profit margin than a $1 million firm with 70% profit margin? So again, don’t get caught up by the sheer cost and say, “If I outsource, I have to pay for that.” Yes, you do have to pay for it.

The question is, how does this work or who are these providers?

There’s no universal term for these kinds of outsourcers. Sometimes they’re referred to as middle/back office firms. Those are offerings where they say, “You go start your own RIA, you do all the client-facing value add tasks, you then outsource to us all the commoditized tasks behind the scenes. We do those for you, freeing up your time (for the reasons I just talked about why that’s beneficial to you.)”

You can even take this a step further. There are RIA solutions you can plug into that say, “Not only will we do everything these middle/back office firms do, we’ll also take it further and do the compliance for your firm as well, so you don’t have to be responsible for that, freeing up even more of your time.”

As to which of these approaches might be best for you, every advisor situation is different, there’s no single answer.  That is part of what I help advisors do is to understand, what are you trying to accomplish? What are your strengths? What are the things you would rather not be doing yourself? And as a result, which of these providers might be best for you?

So, know that these providers exist, again, often referred to as middle/back office providers.

There are also TAMPs nowadays that do much more than just pure money management. They do a lot of additional tasks for RIAs that they service, so that’s a way to outsource as well. So just know that there are providers out there if that’s something you want to explore.

An extreme (but true) example of this, there was an advisor that had over a billion in assets who outsourced almost everything. I can’t remember, he either ran the practice by himself, or at best, had one other team member. But he ran a billion AUM practice almost entirely by himself because he believed in outsourcing anywhere he could. That included middle/back office tasks, that was the managing the assets, etc. Everything he could outsource, he did. He concentrated just on the clients.

Now, were his profit margins as good as other firms’ profit margins? No, because he was outsourcing, paying someone else to do all these tasks. But as a result, he was able to grow his firm to over a billion in assets with this incredibly small footprint directly on his team. So, albeit an extreme example, know this can be done.

I was on a Zoom call just a couple of days ago, and I was telling this story to a team that currently is about a third of the size of this billion dollar advisor. They responded by saying they wished they had done the same thing earlier in their career as well, so that they could have had faster growth by not doing so many non-client facing tasks themselves.

To that, I reminded them that they still had a lot of runway left in their careers. Yes, it might have been nice to do it from the very beginning like the $1 billion advisor had, but such an approach could still be very beneficial to them over the balance of their careers.

Bottom line, be aware that these solutions exist. A way to increase revenues is to outsource tasks that are not directly leading to you growing the firm.

The next topic I want to talk about regarding how to grow revenues is your approach to marketing or business development.

There are plenty of marketing experts that are way smarter on this topic than I am that can give you all kinds of great tips on how to do things. But at a macro level, there’s something I want to point out. Whether you’re an existing RIA now or if you’re thinking about transitioning to the model, make sure to not overlook this.

The more business development, marketing, whatever term you want to use you can do to grow your firm, that will help you increase revenues. That can eventually flow to the bottom line in income.

The analogy I give on this is imagine you are in a one-on-one basketball game. For whatever the reason, your opponent decides to voluntarily tie one of their arms behind their back. Because they voluntarily did that on their own, there’s no reason you need to reciprocate. You have two arms to use and have an advantage over them.

If you’re in that situation, would you voluntarily tie your own hand behind your back? Or would you say, “This is how basketball works. This is what’s available to me. I have both arms. If you choose to voluntarily tie one arm behind your back, I’m still going to play the best I can.”

That analogy is what I see happening a lot in the RIA space.

If you are an RIA, or plan to become an RIA, you will have much more flexibility from a business development standpoint over the tens of thousands of advisors in the traditional wirehouse type models.

In the wirehouse model, trying to do things like make videos, hosts podcasts, write and publish articles, do email marketing, these things are all either not allowed or it’s so onerous to get approved and it’s so slow – due to your firm’s old legacy style way of doing thing – that it doesn’t happen.

RIAs can do all those things. Yet, they are not taking advantage of it. This extrapolates to my analogy. The wirehouse advisor has one arm tied behind their back. There’s a whole lot of things they can’t do that an RIA advisor can, but many RIAs are not taking advantage of it.

If you are an RIA now, or plan to become one, consider the things you can do from a business development standpoint that a lot of your competition – tens of thousands of advisors – cannot do. Take advantage of that!

A related analogy is in reference to the move, “The Shawshank Redemption.”  For those that have seen it, you likely recall when Morgan Freeman’s character “Red” gets released from prison he gets a job at a grocery store.  When he’s working and needs to go to the bathroom, he struggles to go without asking his supervisor for permission first, because for the 40 years he was in prison he always had to get permission.  This is so engrained in him, that his supervisor must remind him he doesn’t have to ask for permission first.

That is something you will experience as an advisor if you transition to the RIA model. If you’ve perhaps spent your entire career in a wirehouse model, and you then go into the RIA world, it is a weird transition where you are so used to not being able to do things that you default to assuming that is still the case.

If a podcast host asks you to be on their show, suddenly you don’t have to ask anyone’s permission, you don’t have to be told no, you don’t have to submit a script ahead of time, etc.  It’s a weird initial feeling. I call it the Shawshank transitionary period.

But don’t get me wrong, you will quickly adapt. It is a refreshing feeling.  If something is available to you, take advantage of it. Grow your firm in ways that a lot of your competition doesn’t have available to them.

When you hear marketing experts give a lot of tips and suggestions, in the RIA space, you typically will have the most flexibility of any affiliation model to pursue those strategies. Make sure you take advantage of it. For a lot of advisors, it’s not even an option.

Now we’re going to shift over to decreasing expenses. The more revenue you can make, and the lower your expenses, the more profit you’re going to generate.

There are three expense items involved in running an RIA that I’m going to talk about here. This is not an exhaustive list, these are just three of the biggest expense drivers of an RIA.

The three items are real estate (office space), your team members, and then the last one is money management. The latter is referring to when you use third-party managed money solutions.  If you’re managing the assets yourself, there’s strategies of how to make that more efficient, but I’m not going to get too much into that on this episode. We’re talking more about third party money management.

The first of these three expense drivers is real estate.

COVID has changed everything when it comes to expectations with real estate. Expectations from your clients, expectations from your team members, expectations from yourself as what is necessary to run an advisory practice. Whatever you thought pre-COVID, the entire world has changed. We are now in a world where Zoom calls are a common day occurrence.

I saw a survey the other day that determined most clients would rather meet virtually, than in a traditional office setting. Pre-COVID, it was the opposite. Whether it’s talking on the phone or doing Zoom calls, the survey demonstrated that the majority of clients now prefer things like Zoom and phone calls, as opposed to having to drive down to the office.

Now, it wasn’t 100% of clients preferring virtual, so in some instances, it still would be helpful to have an office. I’m going to give some examples of how that can still be accommodated. But the tide has shifted, COVID has changed everything with respect to what is possible.

Here’s the dirty little secret with real estate: real estate should be a fixed expense for you, not a variable expense.

If you are in a wirehouse type model, you are receiving certain services and resources from the firm. For better or worse, you’re receiving compliance support. You’re receiving technology. You’re maybe provided with support team members. You’re receiving an office (and it might even be a nice office.)

You’re of course paying for all that. You pay for it via the inverse of your payout. I rant about that a lot in episodes and articles. Every dollar that comes in, your firm retains maybe 60%, and gives you 40%. That 60% is what is covering those services that they are providing for you.

One of those services is an office. The dirty secret with that approach is as your revenue goes up, so does the payout retention that your firm retains. As you bring on more clients, as you grow client accounts larger, the firm is retaining more revenue as a result of it, but yet your office doesn’t really change.

For example, let’s say you double your fees and commissions from one year to a couple of years later. You’ve now also doubled what you are contributing to the firm, via their retention.  Do you now get an office that is twice as big? Do you now get access to a conference room that is twice as big? No, that doesn’t happen at all.

You are paying for office space (via part of the firm’s payout retention) as a variable expense. You keep contributing more and more as your revenues grow,  though your office footprint is likely not changing at all.

You need to ask yourself, “How can I make office expense, a fixed expense?”

If you transition into your own independent practice, you cover the office expense yourself. The benefit is once you exceed the fixed cost of it, every additional dollar in revenue that you bring in becomes incrementally more profitable. The expense for office space does not keep rising like it does in the variable nature of the wirehouse world.

If you are paying for office space in a variable manner, you are not taking advantage of the benefit of operating leverage that you could be in the RIA space. You want to make office space a fixed expense.

With our new current/post COVID world, I’m going to share a few examples of what I’m seeing in the marketplace of ways to decrease office expense even further. This is not to say these approaches will work for every advisor, but they’re examples of what I’m seeing being done.

First, there is an increase in RIAs that are going fully virtual. They have no traditional office footprint. Maybe they did at one point, but COVID has prompted them to rethink their approach.  Firms are saying to themselves, “We don’t need office space anymore because many of our clients want to be virtual, or maybe we’ll go to the client, or we’ll meet in a third party location.”

That’s the extreme example, but if you could eliminate your office expense entirely, consider how that helps your profitability.

These are not just startup RIAs either.  While there are a lot of startup firms that go virtual from the jump, there are a lot of tenured firms that are transitioning their model and rethinking their need for office space

If you’re still skeptical if this will work for clients, let me give you an example. This is an often-shared example, or some sort of variation to it.

Imagine you are a general practitioner in town and there is a dentist that you would like to earn their business and have them become a client of yours. You have nice office space and it is a good demonstration of your practice.

The dentist learns about you, but also learns about another RIA practice that is three states away and entirely virtual (which is a good thing as they are three states away!) The other RIA focuses solely on dentists. Their entire practice is to serve the needs of dentists and provide the resources and expertise that dentists will benefit from.

Which RIA do you think that client might gravitate towards? The one that focuses solely on dentists just like them, or the one with the nice office space? The dentist is likely to go with the niche provider.

Having a niche approach is an often-shared piece of advice.  If you’re providing a specialized offering, it’s much more likely clients will look past a lack of an office footprint. It can be done.

Next, there are advisors rethinking the traditional office footprint in general.  The legacy viewpoint has always been, “If I breakaway and I start my own RIA, I’ll need a few offices or workstations for my team members, a conference room, etc.”

A lot of advisors are now rethinking that and considering whether they need maybe only (for example) half the amount of space. They’re thinking, “We’re already meeting with a lot of our clients virtually, some of our team members now work remote, but we do need at least some office space. Some clients still like that.”

Instead, they might only need a conference room, and a few “floater” offices for whatever team members need to use one on a particular day. As a result, they maybe only need half the square footage they once thought they’d need. They can significantly reduce their office expense.

The third example is, get creative. I’ll give you two quick ideas on this. Again, with COVID, everything’s changed, you can get creative on this.

There is an advisor team I’ve been working with for a while that are envisioning breaking away from their current W2 platform. As part of that they are provided with office space.  However, they are currently meeting with most clients virtually.  For those that want to meet in-person, they typically meet with the client at a local high-end social club the advisors are members of.  The club has very nice facilities, and when needed, the club has meeting rooms the advisors can reserve.  The clients like it, and it is something the advisors are already paying for anyway.

The team is now pondering, “If we were to breakaway, maybe we don’t need an office space at all. We’ll either connect with clients virtually, or if client or prospective clients wants to meet in-person, we’ll just use the nice facilities at the social club. We’re already spending money on it, and our clients like meeting us there. We’ll just do that and won’t need a traditional office footprint at all.”

So again, you can be creative with how you want to do this. The world has changed with COVID.

The other quick creative idea is what I call “snowbird arbitrage.” A typical example is an advisor perhaps in the Northeast in which more and more of their clients are moving down to Florida. The advisor themselves in many cases has a home in Florida and spends part of the year there.

Some of those advisors are pondering, “If I were to breakaway and I need/want some sort of physical office location, as opposed to being in (for example) New York where it’s more expensive to live with property taxes, state taxes, city taxes, etc., maybe I’ll make sure I’m in Florida for more than half of the year and establish whatever office presence I need there. I’ll become a Florida resident and significantly decrease my tax expenses. I can meet my clients either virtually, somewhere in Florida for those that have moved down, or I can occasionally go back up and visit with them in the northeast.”

There are wirehouse advisors that have been able to get away with this sort of thing a bit due to COVID, because regulators have been a little more flexible on location supervision. I think that’s going to get tightened back up and likely go away.  If you leave and start your own independent firm, you absolutely can set up your practice like this and significantly save on real estate and tax expenses.

Ok, moving on, I have two more ideas for how to reduce expenses.

Next, is your team members. Staff expenses are typically one of the largest expenses of running an independent practice. Once way to limit these expenses is, as I noted prior, outsource where you can.

Do you need as big of a staff as you might be envisioning? If you can outsource a lot of the non-client facing tasks of running the practice, you won’t need as many employees directly on your team.

You might want a friendly face on your team that sits and welcomes any client or prospective client when they walk into the office. That might be important to you, I can understand that. You might not want to try to outsource that sort of role. But how many roles are behind the scenes that you could perhaps outsource?

Further, how many of your team members will be working at 100% capacity? That’s typically hard to do because you don’t know when you’re going to have team members out, or when some days are busier than others. In the interim, your staff might only be running at (for example) 70%, 80% of capacity at any given point. That is not efficient as you are paying them for 100% capacity, yet getting less productivity from it.

Consider instead how staffing at an outsourcer can work.  A particular team member of theirs might spend 1/3 their time helping one RIA, another 1/3 with a different RIA, and the final 1/3 on yet another RIA.  They can assign the work to get closer to 100% capacity out of that team member.  That will always be harder for you to do on your own.

Where you can outsource and lower your footprint of team members directly, that can save you money in the long run if you can utilize a more efficient outsourced solution instead.

Another benefit of outsourcing team members is you have less turnover to have to manage. Turnover is a fact of life for any business, it will happen eventually. If you outsource a lot of the non-value-added, non-client-facing tasks to someone else, that’s their problem to worry about. If there’s turnover, they must find new talent, they must train them, they must get them acclimated. You don’t have to worry about all that.

Managing staff vacation days, and having enough coverage in the office, is another related example. If you outsource, that is someone else’s problem for a lot of it.

The less you’re managing these sorts of things directly, the more time you can be working on value-add tasks that help you grow your firm.

If something is non-client facing or you’re not adding value in the sense of the client sees it as adding value, consider outsourcing that to someone else.  Free up our time to do more productive things to help grow the firm. To the degree you can decrease your direct staff, that’s a way to potentially decrease expenses.

The last item for this episode is if you use third party money management solutions.  This might be SMAs, managed models, etc.

I’ll give an example of an advisor in a wirehouse type model. Using very simple numbers, let’s say the advisor charges their client a 1% fee for the services that they provide, and they use a third-party manager that costs an additional 50 basis points to cover the asset management.

All-in, the client is paying 1.5%. Now, mentally, the advisor might think they’re getting 1% of that, and the money manager is getting 0.5% of it. The client doesn’t care though.  All the client knows is that they’re paying 1.5% and they’re getting certain services and value in return for that. They don’t care who gets what portion of the pie.

If you’re in a captive affiliation type model, you likely have limited options of money management solutions to use. In our example, the types of managed solutions you want to use are maybe only available for 50 basis points.

If you breakaway and go into the RIA space, you have the entire universe of options available to you. Different TAMP providers, different money management solutions, different model marketplaces.

Your client is presumably already comfortable paying 1.5% for the value you provide them.  If you transition into the RIA model, there’s no reason you can’t continue to charge your client 1.5%.

However, with the expanded universe of managed money solutions to choose from in the RIA model, consider if you can find a comparable solution for less than 50 basis points. Perhaps you can find a solution that costs – simple example – 25 basis points.

That delta, the other 25 basis points you just eliminated, can arguably go in your pocket instead. Now, you could perhaps pass along some or all of it to the client. But if the client is comfortable – again, in this example – paying 1.5% for the value you’re providing, if you can replicate that same value at a lower cost structure to you, that savings can flow right to your profitability.

With all these topics, the question to ask yourself is, “Are there more efficient, less expensive ways I could do these tasks, or provide these services, if I was in the RIA space?” That’s what I help advisors understand.  What do you have now? How would you replicate it in the RIA space? What would that look like and could that be to your advantage?

To wrap up, keep in mind, the topics I discussed on today’s episode are not an exhaustive list. This was identifying some of the key pieces of how to increase revenues, and how to decrease expenses.

The RIA space is a scale game. The larger the practice you have, the better your economics are going to be.  Always be asking yourself, “How can I grow my firm faster? How can I decrease my expenses?”

For those of you in a captive affiliation model now, your control over some of these things is rather limited. Certain things are provided for you, take it or leave it. In the RIA space you have way more flexibility to look at the different options out there and say, “Is there a better way to do this? And hopefully for cheaper?”

This is the sort of thing I help advisors think through all the time. What is situation now? What would your practice look like in the RIA space? Does it make sense to explore the RIA model? And if it does, how does it work? What options do you have available to you and how do you make the transition to it? I’m happy to have that conversation with you as well.

If you’re not already there, head to TransitionToRIA.com. You can find all these episodes in video format, podcast format. I write articles, I have whitepapers. The most effective thing to do is 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. We can talk about today’s subject or anything else RIA-related you would like to talk about. 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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