Q161 – Should I Join A Broker-Dealer Or An RIA?

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Also available as podcast (Episode #161)

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Should I Join A Broker-Dealer Or An RIA?

TL;DR – The river only flows in one direction. Advisors transitioning to the RIA model typically come from the broker-dealer model.  Yet, we never see the opposite occurring. If you’re thinking about leaving your broker-dealer for another firm, should you look only at other broker-dealers, or should you consider an RIA path? There are both technical and psychological reasons many advisors never look beyond a broker-dealer route, when often they should!

Host:

Brad Wales founded Transition To RIA in 2020 after nearly 20 years of prior industry experience, including direct RIA related roles in Compliance, Finance and Business Development. He has an MBA and has held the 4, 7, 24, 63 & 65 licenses. He has been quoted or featured in 100+ industry articles including in the Wall Street Journal, Barron’s, and most every other major industry publication. He is well known for his RIA video explanatory series, and Kitces named his podcast as a “Top Podcast for Financial Advisors.”

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Full Transcription Of Video:

Should I join a broker-dealer or an RIA? That is today’s question on the Transition To RIA question and answer series. It is episode #161.

Hi, I’m Brad Wales with Transition To RIA where we 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 this entire series in video format, podcast format. There are articles, there are whitepapers. All kinds of resources to help you better understand the model.

Again, TransitionToRIA.com.

On today’s episode, we’re going to talk about if you are a tenured advisor at some sort of firm currently – and we’re going to get into all the different kinds of firms – and that firm is no longer a good solution for you and you’re looking to make a change, should you join either a broker-dealer or should you join an RIA?

Now, as an aside, if you were to go down the RIA path, and as I talk about frequently on these episodes, there are multiple different ways you might go about doing that.

For some of you, it might make sense to even start your own RIA. But that decision process is beyond the scope of this episode.

What we’re going to talk about today is if you conclude that joining an existing firm is the best solution for you – I can certainly help you think that through as to how that compares to maybe starting your own RIA – but if you were inclined to join a firm, the question is…. should you be joining a broker-dealer, or should you be joining an RIA? That’s what we’re going to talk about here.

I want to start with some definitions, both from a technical perspective and realistically from how as an industry we use these terms.

We’ll start with “broker-dealer.”

When you are registered with a broker-dealer, that was when you got your Series 7. Some folks have a 6, but in most all cases, it’s a Series 7.

That exam then enabled you to become a “registered representative” of a broker-dealer. That enables you to work with clients on a transactional basis where you are compensated for those transactions with a commission.

So anytime you have a brokerage commission account with a client, again, where you’re compensated on a transactional basis, you are wearing your Series 7 registered rep hat. And to be able to provide that service, you must be affiliated with a broker-dealer. It was under that broker-dealer hat that you are conducting that service.

When you are under an RIA, that is where you would typically have passed your Series 65. Some of you might have essentially accomplished that with a 66, which is a combination of the 65 and 63.

There are a few carve outs where you maybe have a certain credential that enabled you to not have to take one of those exams, but generally it’s the 65.

Passing that exam enables you to become what’s referred to as an IAR, Investment Advisor Representative under an RIA. The investment advisor representative is the RIA equivalent of what a registered representative is to a broker-dealer.

When you’re wearing your IAR hat, that’s what enables you to open fee-based accounts with clients where you provide your value and services and you are compensated from the client on a fee basis.

There are several different ways you could perhaps charge a fee. The most predominant in the industry is the AUM fee. Maybe you’re charging the typical roughly 1% fee, in return for the value and services you’re providing your client.

When you are doing that on a fee-based advisory basis, you are doing that underneath the RIA.

Now, where those lines start to blur, and where, like I said, I just gave you the technical answer, but the reality is most of you that are at a broker-dealer now are also at an affiliated RIA as well.

The backstory on this is if you go back many decades, most “financial advisors,” as keep in mind there’s no regulatory definition of a financial advisor, there’s a lot of different essentially occupations in our industry that that call themselves financial advisors.

But traditionally that “financial advisor” was solely a registered rep under a broker-dealer. And I’m old enough to know there was an industry magazine once called Registered Rep, and that was the sole hat that you would wear. 100% of your practice was done as that broker, as that registered rep, where you were providing services on a transactional basis and being compensated with a commission.

That was historically how it was done. That is why with some of these long-tenured firms, we call them broker-dealers, because they historically, solely were broker-dealers.

Well, over time, as the industry evolved and client interest picked up and advisor interest picked up, increasingly more and more of the industry has moved to where financial advisors are working with clients on a fee basis, which is the RIA approach I described.

And so most large broker-dealers nowadays that you would think of, when you talk about where some financial advisor is affiliated, are both a broker-dealer and an RIA. Along the way that broker-dealer has started an affiliated RIA, which is often referred to as a “corporate RIA.”

And so financial advisors at that “broker-dealer,” are actually under both the firm’s broker-dealer, and RIA. They’re essentially wearing both of those hats.

So, if you have your 7 and your 65 and you’re at a wirehouse firm, for example, you are technically under both the firm’s broker-dealer and under the firm’s RIA.

The reality though is we continue to refer to a lot of these firms – example, the traditional wirehouse firms – as broker-dealers, because that’s historically what it solely was. And even now that they’re both a broker-dealer and RIA, we just keep calling them broker-dealers.

The same thing occurs with “independent broker-dealers,” IBDs. That’s what we refer to these firms as because we’ve been calling them that for forever. But they also are generally a broker-dealer and an RIA, and the affiliated advisors are operating under both of those and able to offer both of those solutions to clients.

Now, under both of those models, and particularly on the independent broker-dealer side, generally more than half of the client assets nowadays are in fee-based accounts, not commission accounts. That again is because of the trend towards fee-based accounts the industry has gone in.

But interestingly, we still refer to these, for example, wirehouses as broker-dealers. They were once solely, and then eventually predominantly, a broker-dealer that also happened to have an RIA. Well, that’s now switched. They are now predominantly RIAs, that also happen to have a broker-dealer.

But because we’ve forever called them by default, broker-dealers, that’s what we continue to call them. Just know, though, advisors at such firms are generally wearing both of those hats.

The reason I want to give that definition is for when during this episode I refer to a broker-dealer, I’m using it in the same way most everyone in the industry uses it. Even though those firms are both a broker-dealer and an RIA.

And for reasons we’ll get into a little bit, many RIAs also have an affiliated, what’s often called an “RIA-friendly broker-dealer.” So they too at times have both of those hats.

So, that’s a high level from a technical perspective, from a normal industry jargon perspective.

In addition, keep in mind when it comes to broker-dealers, there are different models.

There are W2 broker-dealers, where if you’re affiliated with them, you are a (W2) employee advisor of the firm. That is the traditional wirehouse firms that we refer to. There are many so-called “regional” broker-dealers that have that W2 model as well.

There are also 1099 broker-dealer models. Those are typically referred to as independent broker-dealers. When you hear that term, someone’s usually referring to the 1099 broker-dealer variety.

It’s not the point of this episode to discuss how those differ, but just know when I’m referring to broker-dealers, it could be the W2 or 1099 version.

And the same thing is on the RIA side of the house. While there are some wonderful solutions that are 1099 RIA models you could join, there are also some good solutions that are W2 models you could join.

I’ve done separate episodes on what is a 1099 RIA model, and what is a W2 RIA model, if you want a deeper dive on those.

Now, back to the original topics of which should you join, a broker-dealer or an RIA.

If you’re looking to make a change, looking to leave your current firm, should you be joining a broker-dealer or an RIA?

There’s are several decisions that go into that.

First, a fairly black and white part of the decision process is how much of your practice is now on that fee basis side, versus the commission basis?

A good boilerplate starting point, if more than 70% of your practice is now fee-based, you arguably should be heavily, if not entirely, leaning towards the RIA path for what would be best for your practice going forward.

Now, mind you, I did not say it has to be 100%. That’s an often misconception about the RIA space that you must be 100% fee-only to go down the RIA path.

There are many RIAs that are 100% fee-only, but you absolutely do not have to be 100% fee-only. There are several different ways to accommodate whatever that remaining portion of the broker-dealer assets are.

I’ve done episodes on that as well. I’m happy to have a conversation with you about your specific practice, what that would look like. But the idea being it doesn’t have to be 100%.

But 70% and above, which is implying 30% or less is still on that broker-dealer side, you absolutely are a candidate to be exploring the RIA model.

Now, if you’re 50 to 70% fee-based, it still might make sense, but that also means you do have a very large amount of broker-dealer business still. That’s kind of the gray area.

And then, if you’re about 50-50 commission and fee with your practice, or certainly if the majority of your practice is still commission-based, you probably are going to be better off at a broker-dealer because that is what they are built for. They are built for that transactional commission-based practice.

So if 60 or 70 or 80% of your practice is transactional, commission based, you probably should be at a broker-dealer.

But as the pendulum swings more and more to the fee-based side, that’s where you should be resetting your thinking. No matter which paths you’ve taken so far in your career, which perhaps early on was very commission based but is now more fee-based, you should maybe now be leaning towards the RIA model.

So, that’s some easy, simple numbers as a starting point.

Now you also want to factor in, why might the RIA model be better than the broker-dealer model in general?

I’ve done an episode on this topic, but at a high level, some of the reasons that advisors typically start wanting to lean towards the RIA space, again, assuming the numbers work, is for different motivations. But no matter how those motivations are expressed, they typically fall into one of two buckets. And I’m just going to do this high level because it’s a whole topic unto itself.

The two buckets of different motivations for why advisors go down the RIA path are one, something related to a desire for better economics, or two, more flexibility with the practice. And generally it’s both of those.

At a high level, the desire for better economics are things like literally having a higher income. There’s a lot of nuances that go into it, but generally you can make a higher income with your practice in the RIA space than you could in that traditional W2 broker-dealer type world.

That’s because you can do things like control your local P&L. There are a lot of reasons that is to your benefit to be able to do that.

You also might be seeking the higher valuation that is almost certain to come along with your practice being in the RIA model versus the traditional broker-dealer model, for when you’re at the end of your career looking for that liquidity event.

And keep in mind, that’s not just the enterprise valuation of your practice, that’s also how it’s taxed, that’s how you actually can structure the deal.

That’s just scratching the surface, there are several economics advantages to the model.

The other bucket is flexibility.

This matters what you want to do with your practice. Perhaps you’re at a wirehouse now and you don’t feel any sort of constraints from how you manage your practice, and perhaps that will continue to be a fine model for you.

But oftentimes there’s a lot of reasons advisors are seeking more flexibility in their practice. Whether that’s with the services they can offer their clients, the investment solutions they can offer, they want more flexibility with how they can market their practice, whether from building a brand or starting a podcast or whatever they want to do.

There are all kinds of reasons on a flexibility front that it can be more appealing to consider the RIA model.

So, you want to factor those in when saying… “If I’m going to join another firm, should I be joining that broker-dealer world or should I be joining the RIA space?”

You want to have that conversation with someone like me to understand… what does your current practice look like, and equally if not more important, what would you like the future of your practice to look like over the balance of your career?

And how do the different dynamics of the broker-dealer space versus the RIA space differ from each other? Again, it usually comes back to economics and/or flexibility.

Next, two main points I’ll leave you with.

First, if your practice is, again, predominantly leaning towards the fee side, and you have this choice of should I be looking at a broker-dealer model or an RIA model, you want to consider these firms from a historical perspective.

There are many broker-dealers that have been around a very long time. And again, they were initially solely a broker-dealer, and essentially have had to be evolving their firm over time. Perhaps you want to use the term “reinventing” themselves over time as fee-based as a way to do business with clients has become the more predominant way to do it.

The reality is they are having to reinvent themselves. That is decades of technology that was built to service transactional commission brokers. That technology is being forced to evolve.

That’s perhaps decades of institutional knowledge and ways of doing things, as an example, maybe from a compliance perspective, that was done predominantly with a commission brokerage mindset that is having to evolve with time.

Compare that to if you look at some of the RIAs in the marketplace. They were started as RIAs. They are not reinventing themselves. They were started as RIAs, reflecting that’s where the industry was going.

And yes, they might have an accommodation for your remaining, often referred to as legacy commission assets. But the way they’ve built the firm, the technology they’ve put behind it, the policies and procedures they’ve built, the solutions they make available for you with your clients, the flexibility they give you, is based on RIA first.

And again, to the degree you even need their broker-dealer accommodation solution, that is secondary with it.

If your practice is 70% commission, well, you probably should go with the firm that is historically, and has been built off of that broker-dealer chassis, that broker-dealer mindset.

If you are one of the advisors or teams that your firm is now predominantly fee-based, you should be looking at the firms that are predominantly and primarily built to service that type of advisor. That’s looking at the RIA model.

There are firms that were started with that approach in mind. They’re not having to reinvent themselves or trying to redo technology or decades of institutional knowledge. They were built from the beginning to service the predominantly fee-based advisor.

So, keep that in mind as one of your lens.

And then last, it is worth your while to at least be exploring this topic.

If you are watching or listening to this episode, good job. You’ve at least dipped a toe in this.

But there are many advisors out there that have historically only ever been at – we’ll pick on the wirehouses – they’ve only ever been in the wirehouse channel, and maybe only one firm in the wirehouse channel.

If forever reason that firm is no longer the solution they think is best for them, and they are going to make a change, going to go join another firm, many have a mindset that they should only be looking at other broker-dealers, whether that’s the W2 broker-dealers, like wirehouses, or 1099 independent broker-dealers.

But they have a mindset of… “I’ve always been at a broker-dealer. I guess I still need to be at a broker-dealer.”

Well, maybe you don’t!

But there’s this mindset that you just keep the status quo.

Again, if your practice never evolved over the last 10, 20, 30 years, and you are still that predominantly transactional commission-based broker, yes, you are correct, you probably should stay in the broker-dealer channel.

But if your firm has evolved, don’t have blinders on. Don’t just assume the RIA model is not for you. It behooves you to at least learn more about it.

Again, good job, you’re watching or listening to this episode, you’re beginning that process. But talk to someone like me, and let’s ask… “What does your practice look like now? What do you aspire to do with it going forward? Is the RIA model a potential fit for that?”

We can get to that relatively quickly. You don’t have to invest hours of time just to determine if it’s worth exploring further. Have a conversation with me and we can quickly determine it. That can be done relatively quickly.

But just be open-minded. Just because you’ve only ever been in one channel or only one firm your whole career, keep an open mind and say… “I owe it to myself to at least understand this RIA path to see if it is something I should be exploring further.”

Like I said at the top, my name is Brad Wales with Transition To RIA. This is the type of conversation I have with advisors all day long. Helping you understand what this RIA model is all about. Is it something you should be exploring?

And then if it is, that’s just the beginning of the process. There are all kinds of decisions and solutions and pathways and models that you will want to be aware of.

I help you understand all that so you can make an informed and educated decision on whether to go down this path to begin with. And then if it does make sense, what is the best way to structure it for your particular practice. Because every advisor and team is different. I’m happy to have that conversation with you as well.

First things first though, head to the website at TransitionToRIA.com where you’ll find this entire series in video format, podcast format. There are articles, there are whitepapers.

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 in today’s episode, and I’ll see you on the next one.

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