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Also available as podcast (Episode #122)
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Is The Payout In The RIA Model Really 100%?
TL;DR – If you have your own RIA, yes the “payout” is 100%. It isn’t actually a payout at all, you are simply receiving 100% of the fee revenue you generate from your clients in return for the value and services you provide for them. However, you must also account for the necessary expense of running an advisory practice to be able to provide the value for your clients.
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Full Transcript:
Is the payout in the RIA model really 100%? That is today’s question on the Transition To RIA question & answer series. It is episode #122.
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 model.
Again, TransitionToRIA.com.
On today’s episode, we’re going to talk about, is the payout in the RIA model really 100%?
That’s sometimes you see out there. That’s how it’s being positioned. Hey, transition your practice into the RIA model, get 100% payout. And you would think me, the RIA guy, the guy where all I talk about is the RIA model, would be preaching the same thing.
But if you follow along on my episodes, you don’t see me leading with that. Leading with you will get a 100% payout.
And so what I want to talk about on today’s episode is where that is factually correct at times, but you must understand the nuances that go with it.
Oftentimes when you hear the rah rah headline, or in advertisements, about 100% payouts. Well, that’s true, but you must know the details that come with it. That’s what today’s episode is going to be about, is the payout really 100%?
As I talk about often on these episodes, that are a couple different pathways you could take to go into the RIA model. And when we talk about payouts – I’ve done episodes on various topics around payouts, you can go back and look at those as well – but it’s important that you’re ultimately talking about this in an apples-to-apples perspective.
For example, one of the affiliation models in our industry is the traditional wirehouse W2 “broker-dealer model.” Those firms have compensation plans for their advisors. Which I’ve ranted about such plans in several episodes, some of the nuances of those comp plans.
In that model, when talking about a payout, for the most part, that is saying… “you, advisor, go out there and provide service and provide value for your clients, of which you charge a fee.” (We’ll just make this conversation on the advisory side of things as opposed to commissions. It’s roughly the same, but some differences.)
So you are out there, you provide value, you provide services to that client, you are charging them a fee. Perhaps the proverbial 1% AUM fee. The client pays that. In the wirehouse world, the payout is essentially ultimately what, for the most part, goes in your pocket.
If it’s 100 cents on the dollar comes in from the client, depending on your size, perhaps 40 cents of that, 40% or so, goes into your pocket.
Now, out of fairness to the wirehouse firm, they are providing you, as the advisor, certain things for that 60%, the bigger piece of the pie, that they are retaining. They’re providing you an office, they’re providing you technology, they’re providing you maybe a team member, a staff member.
They are covering certain costs for you, and for that, they take the lion’s share of the fee that the client has paid. So the “payout” is what ultimately comes to you.
To make sure we’re doing an apples-to-apples comparison across affiliation models, keep in mind that what that payout grid says you get (in the wirehouse model) is not always accurate. It is not always the bottom line you get.
As an example, I just did an episode ranting about how wirehouses typically use deferred compensation in their comp plans.
If the payout grid, the little chart says, because of your production level, you get 40%, but they might be deferring some of that into the future. So maybe only 35% is going in your pocket as a true payout.
And yes if you stick around long enough, and yes if you never leave the firm, and so you don’t lose any of it along the way, you would eventually get what was deferred. But the income you’ve earned from providing that service today, in this case perhaps only 35 cents on the dollar, goes in your pocket.
So in that scenario, the payout is what goes in your pocket after everything is taken out.
Now, let’s shift to the independent broker-dealer model. We use the same word “payout”, but we use it in a different capacity.
In the independent broker-dealer model, the payout is much higher than it is in the wirehouse model. But that’s because in the independent broker-dealer model, you as the advisor control most of your so-called “local expenses.”
Going back to our example, you charge a client a fee. 100% of it comes in to the independent broker-dealer. They provide you some value and services just like the wirehouses, but not as much. They are still generally providing you technology, compliance – for better or worse.
But with the independent broker-dealer model, they are not paying for your so-called local expenses. Paying for whatever your office setup. Paying for your staff. Paying for your utilities. Those sorts of things.
So the payout in the independent broker-dealer model is typically much higher than it is in the wirehouse model. But that’s because you then need to pay for your local expenses. (I’m going to finish the episode talking about why that’s to your benefit to control your local expenses, so I not suggesting doing so is a bad thing.)
But the idea is your payout (in the independent broker-dealer model) is perhaps say 90%, but from that you must cover your local expenses.
To make it even more confusing though – I talked about this in some episodes – you must consider if all the economics are involved in that payout.
As an example, with many independent broker-dealers, and even some wirehouse firms, there might also be a “platform fee” that the client pays as well. Maybe you charge the client a 1% “advisor” fee, but then your firm maybe also has a 25 basis point “platform fee.”
And you might be managing the assets, this is not necessarily referring to an SMA or something like that which would clearly have additional costs as well.
In this example, the client is maybe paying 100 basis points to you, and an additional 25 basis point platform fee. They’re paying 125 basis points all-in.
However, your payout, that 90% headline number, is not on the 125 basis point fee the client pays, it is only on the 100 basis point advisor fee.
When you run that math, your payout on the all-in number the client pays, is typically maybe in the 70% range. And you then still must cover your local expenses.
Not all accounts scenarios have a platform fee, not all firms have platform fees, but it’s something to be mindful of.
If you have a client that is able and willing to pay, in this example, 1.25% fee for all the value and services you are providing them. They don’t really care who gets paid what behind the scenes. They just say, what am I paying and what do I get in return for that?
If you were to go, as an example, to the RIA model, there’s no reason you couldn’t keep the overall fee at the same 1.25%.
A lot of advisors that I talk to, in particular, at independent broker-dealer models, and I’ll point out the platform fee, and they say… “I don’t pay that, the client pays that.” And I say… “Yes, that’s correct, but what happens if you go in a different path and the client will still pay the same total fee, but you receive more of that fee yourself.” That’s where this starts to become a meaningful difference between these platforms.
In the RIA model, there are multiple pathways into the model. You can start your own RIA. You can join an RIA. And there’s a third flavor in the middle.
I help advisors understand all three. I help advisors explore and potentially go down all three, whichever one might make sense for your practice. So my comments are not meant to suggest one is better than the other. They all have pros and cons. It’s to help you – this is what I do – understand how they’re different and figure out which path is best for you and your situation.
But for this episode, when we’re talking about payouts, if you were to conclude that starting your own RIA is the best path, in that case, yes, the payout is 100%.
It’s not even a “payout” by definition.
When you establish your own RIA, you need, among other things, a custodian to hold the client assets. There are several solution providers you need to piece together, but it is the custodian that holds the assets.
When it comes time to process your client fees, perhaps you’re on a quarterly fee schedule, that fee is not revenue to the custodian. That’s your fee. It is not revenue to the custodian and they then “payout” 100% of it to you. It’s not the custodian’s revenue. It’s not the custodian’s fee.
The only thing the custodian does in that – not to minimize them, they’re holding the assets, clearing trades, all that – but when it comes to the fee, the RIA instructs the custodian – it’s all automated, done through technology – here’s my clients, here’s how much the quarterly fee for each is, deduct it out of their accounts and remit the fee to me.
It’s not really a payout at all. They are simply, as a courtesy to make it more efficient for you and the clients, taking it out of the accounts per your instructions, and giving you the fee that you have generated. You have provided a service, there’s a fee, here’s the fee.
But it still is often described as a 100% payout, even when that not effectively what’s occurring.
Now from the 100% that flows to you, like the independent broker-dealer model, you need to cover your so-called local expenses. And with the RIA model there are additional solutions you may need, such as doing your own compliance. I talk a lot in these episodes about how to manage the compliance responsibility.
But the idea being, unlike the independent broker-dealer, you are keeping 100% of the fees that you generate, and from that, you then work down what needs to be paid.
I have a checklist that helps position this by basically saying you need to ask yourself, what does your current firm provide for you now? Whether you’re at a wirehouse, an independent broker-dealer, whatever your situation is, what does your current firm provide for you now?
They provide you things depending on your affiliation model. It could be an office, technology, staff, marketing support, E&O, whatever the case is.
And then if you were to start your own RIA, you ask yourself, how will I replicate all those needed pieces? What would that cost me? And how does that compare to what they’re providing me, and what they’re charging me?
At its very basic core, that’s what a transition to the RIA model is. What does your current situation provide for you? How much do they charge? How would you replicate those needed services on your own. What would that cost you. What are the differences between the two?
So yes, it’s 100%, but yes, you have expenses to cover.
But generally, and this is why there is a big migration to the RIA model, the bottom line math after you’ve done all this is generally better than any of these other models, particularly the wirehouse model which in almost every circumstance is meaningfully better.
However, the better economics come with additional responsibilities, that perhaps you don’t have in the wirehouse model.
A quick example, if you’re in the wirehouse model, for better or worse, you don’t have to worry about the lease on the office, or anything to do with furniture, or anything like that. You don’t have to worry about paying the utility bills. You don’t have to worry about the technology.
They provide it for you. Now for that, they take the biggest chunk, the lion’s share of the fees and revenue you generate.
In the RIA model, you are responsible for each of those. It’s doable though. There are 30,000 RIAs out there. Not 30,000 advisors in the RIA model, that’s hundreds of thousands. But 30,000 RIAs. It’s entirely doable to put all these pieces together.
That’s what I help you with. What are the pieces? Who are the vendors? How do you manage them? Blah, blah, blah. It’s entirely doable, but it is more responsibility than you would have in the wirehouse model.
The equation is then to ask… What is the additional responsibility? What additional economics do I gain from taking on that responsibility? What additional flexibility and freedom of my practice do I gain from doing that?
Both of those can be meaningfully improved in the RIA model, but it does come with that responsibility. You need to understand both sides of the coin. That’s a frequent topic of conversation I have with advisors.
And then the final payout related topic I wanted to mention revolves around if you want a lot of the benefits of the RIA model, the better economics, the more flexibility, freedom that comes with it. But maybe you don’t want to be responsible for as many of those pieces yourself. Building the tech stack, those sorts of things.
As I discuss often, there are multiple pathways into the RIA model. One pathway you should potentially consider is, should you join an existing RIA solution?
Now, this is not, at least what I discuss with my audience, this is not just some RIA down the street that has an empty desk in the corner and they’d love to have you come sit in it. That exists out there in different forms and if you find that person and you like the desk in the corner, have at it.
I am not referring to where you must sell your practice to an RIA to join them. That exists as well. There’s nothing wrong with that, but that is generally only appropriate or attractive to advisors at a certain stage in their career. Typically more towards the end where they’re looking for their succession.
Most of my audience is saying… “I’m still mid-career. I’m trying to build this. I just want better economics. I want more flexibility.”
And for those advisors, there are, as I call them, purpose-built RIA platforms that from the start, they were built to say… “Advisor/team, we realize you want all these benefits. You don’t necessarily want to have to piece all those things together yourself. So look, we’ve pieced together, 60%, 70%, 80 % of all the pieces that you would need. We’ve bundled it up, we have more scale than you do so we can get better pricing on things, blah, blah. Here’s how we price it. We’d love to talk to you about what this looks like.”
And under that circumstance, you retain 100% ownership of your practice. You’re 1099, and control your local expenses. You use your own brand. They’re basically your behind the scenes infrastructure partner, if you will.
So that exists, all different kinds of flavors. I’m happy to discuss that with you.
But in that world, there is a payout as well. I did an episode of what is the payout if you join an RIA. Check out that episode for more details. But in short, the payout can be expressed in different ways. Sometimes it’s a percent of revenue. Sometimes it’s the inverse of that. Sometimes it’s basis points. Sometimes it’s a combination of the two.
There is not as much uniformity in the RIA model from a payout perspective if you were to join a firm, as there is in the broker-dealer model. Where, for example, the wirehouses all have pretty similar comp plans and pretty simpler grids and that sort of thing. It’s much more disparate in the RIA model. Helping you understand all that is part of what I can help you with.
But the idea is these RIA platforms have a payout and they say… “Here’s all these things we’ve bundled up for you. Here’s everything we provide. Here’s the payout, and from that you then control your local expenses.”
So that’s an additional version of a payout.
The main takeaway though is to confirm…. yes, there’s a path if you start your own RIA that the “payout”, even though it’s not really a payout you’re just getting the fees that you are generating as a business, is 100%.
But be careful as that same term “payout” is used in different ways, as I noted, in the wirehouse world, independent broker-dealer world, or maybe you’ve joined an RIA.
The final thing I want to leave you with, I mentioned earlier the benefits of controlling your local expenses.
With the wirehouse model, they do all that stuff for you. They take care of the office. They take care of the technology. They take care of all that. Well, that’s great, but they also in turn take the lion’s share of the revenue that you generate.
Now, they do have costs associated with that and, for providing you that service, they’re generating a margin on their revenue as well. That is a path that is attractive to many advisors and will remain attractive no matter how much better the economics could be in an independent path or better the flexibility and freedom could be.
Some advisors say… “I just want to be an advisor. I don’t want to deal with all that. I realize I’m making less income. I realize when I sell my practice one day, it’s going to be perhaps meaningfully less valued, particularly after taxes. Maybe I have less freedom and flexibility. But it still works for me. I have a nice life. I make a nice income. I’m good.”
That’s fine. That exists. But to the degree you want to take advantage of it, the advantages of an independent path can be immense.
An example, whether you join an independent broker dealer, your own RIA, join an RIA as a 1099, is you control your local expenses. A couple highlights why that’s beneficial…
First, when you control your local expenses, you only pay for what you need.
As an example, if you’re starting your own RIA, part of that is putting together a tech stack. I did an episode on what is a tech stack.
If you’re at a firm now and they’re providing you with all the technology – and by the way, you’re paying for that, you don’t get an itemized bill, it’s part of the inverse of your payout – they’re probably providing you a lot of technology you’re not using.
For better or worse, you’re only using a subset of it. But they have all the technology because other advisors are using a different subset. But guess what? Everyone gets charged the same via the payout.
If you have your own RIA, as an example, you only pay for, and implement the technology that you specifically need and want. Everything else you don’t get, and don’t pay for.
Controlling your local expenses is picking what you need and only paying for what you need.
Related, you are free to only pay for vendors who are helpful.
If you’re at a wirehouse, an independent broker-dealer, those firms should be viewing you as the customer. Afterall, without you, and your clients working with you, they don’t exist. The wirehouse, at least the wealth management side, does not exist without advisors.
Everyone at the home office should be viewing you as… what can we do to keep these folks happy because we don’t want them to leave because this is the business we’re in and they’re our customers.
Unfortunately, that’s not typically how most of the folks at the home office operate. I’ve seen it firsthand. Early in my career, I started at a large broker-dealer and I was in a compliance department and you would see people – and the firm was trying to not have this attitude – but you’d see people in the compliance department who didn’t view the advisors as the customer. They were on a quest to find what an advisor might have done wrong. What can we stick them with? If it’s bad enough, can we get them fired?
My attitude though was always… “Hey guys, the advisors are who sign our paycheck. Without them, there is no us. Yes, we still have a job to do and they need to follow regulations, but we need to treat them like customers and try to keep them happy.”
Unfortunately, that’s not how it typically is playing out in a lot of these large, wirehouse type firms or broker-dealers.
In the RIA space, because you’re going out there and establishing relationships with all these different vendors – whether it’s a compliance solution provider, technology, E&O, etc. – if those vendors are not helpful to you, if they’re not responsive to you, if they’re not competitive with what’s out there, you can fire them and replace them with someone else. That’s because you have the local control over what you pay for.
When you’re at these large brokerage firms, it’s a one size fits all, take it or leave it, for better or worse. The only recourse you have is to leave the firm altogether if one area is not providing you good value or service.
But again, in the RIA space, you typically can hire and fire as you need to.
Another example with local expenses is because you control it, you can manage the P&L, the profit and loss statement, the net income statement.
If you want to have a very extravagant office setup, and a very large team, have at it. You can do that. It’s your choice. You’re controlling your local expenses. However, that is going to make your bottom-line net income lower.
If instead you run a lean operation, and have a modest office and a staff that is very efficient, that’s going to increase your net income.
Being able to control your P&L is a huge benefit.
The final example I’ll give you, and this is not an all-inclusive list regarding local expenses, but this one is a huge advantage in the independent space. I did an episode on this. It’s being able to potentially own the office space you use.
Many of you in an independent model might lease an office. That’s fine, but there’s a pathway – and maybe you can’t do this as part of the transition, perhaps it’s a longer term goal – is to own the office you are in.
No matter which model you’re in, if you’re at (for example) the wirehouse model, you’re paying for an office. You don’t get an itemized bill, it’s built into the inverse of your payout. But you’re paying for it. If you stay there for the next 20, 25 years, you are paying for an office, a lease effectively, for 20, 25 years. And at the end of that, you don’t have anything to show from a real estate perspective.
If instead you’re independent, and need an office (vs maybe a virtual approach) and you’re going to be in the game for another (for example) 20 years, you can buy a building, and pay the note on that vs leasing from someone else.
I get it, it’s easier said than done. But buying a building over the next 20 years – paying down the note on the building, if that’s how you acquire it – then at the end of your career, not only do you have your practice to sell, you also now have a real estate asset as well. Which could be an extraordinarily meaningful addition to your wealth.
That’s just not available in the W2 broker-dealer world. You’re provided with an office, and for better or worse, you’re not building equity in that office. That’s just another example of the benefits of controlling your local expenses.
As I said at the top, my name is Brad Wales with Transition To RIA. This is the sort of thing I help advisors with all day long is saying… “What does your practice look like? What are the economics you have now? What might the “payout” be in the RIA space?”
Part of my value proposition is helping you understand the different pathways into the model, which might be best for you, how the economics would look depending on which pathway you go down, etc. I’m happy to have that conversation with you as well.
First things first, 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 model.
And 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.
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