Q66 – Should You Change Affiliation Models During Challenging Market Conditions?

Also available as podcast (Episode #66)

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Should You Change Affiliation Models During Challenging Market Conditions?

Walk into a hair salon and ask a stylist if you need a haircut.  Any guesses what their answer will be?!  The same can be said at times when prognosticators give advice regarding whether you should change affiliation models/firms, during a choppy market cycle. There is no one-size fits all answer to this question.  However, there are a number of variables involved, which if considered, which will help you navigate whether a pause in your plans is in order, or whether this might be the best time possible to be making a change.

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Full Transcript:

Should you change affiliation models during challenging market conditions? That is today’s question on the Transition To RIA question and answer series. It is episode #66.

Hi, I’m Brad Wales with Transition To RIA, where I help you understand everything there is to know about why and how to transition to the RIA model.

If you’re not already there, head to TransitionToRIA.com, you can find all of the resources I make available. I have this entire episode series in video format, podcast format, I have articles, I have whitepapers. All kinds of resources you can use to learn more about the RIA model.

And for those of you watching this on video, if you’re more of a podcast listener, check out the “Transition To RIA Podcast” on all major podcasting platforms, where you can follow along on all of my episodes in podcast form as well. Again, search for the “Transition To RIA Podcast.”

On today’s episode, we’re going to talk about whether a volatile market should preclude you from making a change to another affiliation model or another firm.

While I talk about the RIA model, the same thought here applies to making any sort of change within the industry. From one W-2 firm to another, or to an independent broker-dealer, or, again, RIA model, whatever the case is.

I want to give some thoughts on how to approach this if you’re thinking this topic through as well.

The first thing I wanted to go into is to remind you, always be careful about who is giving advice on this topic. Who is answering this question, if someone says, “Should you make a change during a down market period?” You must be careful about who is providing that advice. I want to give you a couple of examples of that.

The first is one I always find comical. I’ve been to dozens of industry conferences over the years, as I’m sure many of you have been to many conferences yourself. There are always speakers, maybe a mutual fund manager giving advice on what they think about the markets.

We’ll pick on a mid-cap fund manager. I’ve been going to conferences through all kinds of market cycles. The manager is always asked, “Is now a good time to invest in the mid-cap space or a mid-cap mutual fund?”

It doesn’t matter what the macro-environment is. It could be the greatest bull market ever, that mid-cap manager is going to say, “Absolutely, this is the time you want to be in the mid-cap space.” Or it could be the day after Black Friday and the worst bear market ever, that mid-cap manager is still going to say, “This is the time you want to be in the mid-cap space.” Because obviously, they are in the business of having people invest in their fund, in their space.

I don’t even know why they ask that question because we already know the answer. The answer is always going to be, “Yes, of course, you should. The time I’m positioned for, is right now.”

Another example, that’s comical, are chief economists at realtor associations.  You see them quoted in the press being asked if now is a good time to be buying a house? Every single time they are asked that question, they always say, “Yes, we think prices will go up.”

Now, it might be, prices will go up more modestly or more aggressively, but you will never hear one of these chief economists – who are supposedly giving unbiased expertise – suggest, “Oh yeah, next year, we definitely see prices going down.”

Saying that is not good for their association members, the realtors who are trying to get people to buy or sell houses. So, you always have to be careful about who you hear advice from.

With respect to today’s episode of whether you should make a move to a different affiliation model or a different firm during a turbulent time in the market, you must be careful as well.

There are headhunters out there, recruiters out there cold-calling advisors, possibly cold-calling you and, of course, they are going to say by default, “Absolutely, this is a wonderful time to make a move.” Because they are in the business of helping advisors make a move from one firm to another.

That’s fine, that is the business they are in. But you must take that with a grain of salt that they’re going to tell you the same thing no matter whether the market is up, or down. So, factor that in when you hear that coming from someone in that kind of capacity.

Another example is independent firms. Independent broker-dealers or the RIA space. They are in the business of helping advisors leave the more captive world, that W-2 world, to go into a more independent space. So, naturally, they’re not going to suggest that there’s a bad time to make that move because they are in the business of helping people make that move. They are always going to say, “Yes, now is a good time to be making the move.” So, again, you need to factor in what their motivations are.

Now, an example of the opposite is if you’re at a W-2 firm or a wirehouse firm, you might hear your branch manager putting whispers out of, “This is not a time anyone would want to be making a change, not with these market conditions.”

They have an incentive to try and not lose advisors from their branch, so they put out commentary that will maybe scare anyone who was thinking about leaving, “Oh, you definitely don’t want to leave under these conditions.”

Now, this is disingenuous, because if they have an opportunity to bring an advisor into their branch from another firm, they will gladly do so. Which is the exact opposite of what their advice is that they might be putting out in a whisper campaign.

In full disclosure, I’m not living in a glass house throwing stones. I help people transition to the RIA model. I’m not going to sit here and say, “Oh, I don’t have any interest whatsoever in whether people make changes in their affiliation models,” because I help advisors make the move to the RIA model.

What I try to do on all of my episodes, is always be a straight shooter. I talk about the pros, cons and give different perspectives. That’s what I’m going to do on this episode. But I will acknowledge, that is the business I’m in, so no one can accuse me of saying, “Oh, Brad, you’re pointing fingers at all these people, and what about you?”

So, take my advice, my feedback into consideration as you desire, but again, my goal here is to try to give you different perspectives on the pros and cons of making a move under these conditions.

Next, I want to touch on some of the answers I hear to this question, and then add my thoughts to it. Some of it, I don’t want to say is disingenuous, because that maybe sounds a little harsh, but there’s more perspective to it.

The first example, is when you see a broker-dealer asked – often in an analyst call, because they’re a publicly-traded company – “With the market downturn, is this going to slow recruiting into your firm?”

Oftentimes that response is, “Let me remind you, we had record recruiting back in the ’08, ’09 downturn.” So, clearly, advisors make a move during a downturn. And clearly, there is interest from advisors to do so.

Now yes, that is true. And there are good reasons, we’ll get into some of them, why making a move now is a good time to be doing so regardless of whether the market is down or not.

However, the folks that are quoting record recruiting in ’08, ’09, there’s a little more to that. I was with a large independent broker-dealer at the time, I was in the trenches of business development, the recruiting of that broker-dealer during that ’08 and ’09 period. And yes, absolutely, there was a crush of interest from advisors wanting to leave wirehouses or W-2 firms and come to this more independent space. And yes, a lot of those advisors made those moves. It was a record recruiting year during that time.

Advisors were making moves for reasons that still apply today.  However, in ’08, ’09, there was amplification due to valid concern that certain firms were going to go under. They were going to disappear and advisors wanted off the ship before it possibly sunk.

An example was Merrill Lynch. There were plenty of Merrill Lynch advisors that had no desire to leave Merrill Lynch. They thought they never would leave Merrill Lynch. Mother Merrill was going to work well for them. Suddenly, they left work on a Friday, and when they came back in on Monday, they now worked Bank of America.

That was a very big wake-up call. If Merrill went down as an independent firm, who else could go down? And then, by the way, Bank of America itself, during those scary times, there were questions would they survive?

There was this enormous exodus of advisors looking to get off of what they feared was a sinking ship that could go to the bottom of the ocean. So, yes, there was record recruiting during that downturn. Yes, there are good reasons advisors were making those moves. But it’s disingenuous to quote those records and not also acknowledge there was also a fear of firms going under and that did amplify that exodus in those record results.

So, just something to take into consideration when you hear that kind of commentary.

Next, is when you hear someone say, “You shouldn’t make a move during a down market.” I gave an example of who you might hear that from.

Let’s say you buy into that advice. It’s a down market, I’m already busy with my clients, I’m already having to handhold them through this volatile market, so maybe in my mind, that’s not a good time to be making a move.

But consider the opposite as well.  I see this aplenty when markets are going up, you have a lot of unsatisfied advisors at maybe large W-2 firms or wirehouse firms that want to make a move. They know they’re going to be better off in a more independent space, they want to make a move but when the market is going up, that pain is a little less amplified.

Every year I’m making more money. There’s more compensation going in my pocket because the market is going up. My compensation is going up. Yes, this is awfully frustrating at times. Yes, I would prefer to be in a different model. But things aren’t bad year after year, because I keep making more money.

The problem is, if you’re not going to move if the market is down, and you’re going to get complacent when the market is up. If it makes sense for you to move and you want to move, it’s not going to happen if you’re going to not do so in either a down market or up market.

You can’t use that as an excuse. You can’t say, “Oh, not in a down market,” if you’re also going to say, “Not in an up market either because I keep making more money?” So, something to consider.

Next, is when you hear a W-2, or an employer wirehouse branch manager might tell you, “In a down market, aren’t you glad that the fixed costs of running the firm – like, for instance, the lease on the office – that is not your responsibility. That’s our responsibility at the firm. We’re the ones that have to keep eating that fixed cost. So if the market is going down, and your production is going down, well, you’re not the one having to eat that fixed cost. That’s staying static.”

That is functionally correct. As your variable revenue goes down, you’re not having to cover the fixed costs. Your firm does.

However, what is not said by those same folks is, what happens when the exact opposite occurs? When the market goes up? Historically speaking, market’s go up more than they go down, and certainly over the long-term.

Let’s say your payout tops out at 50%. I’ve done all kinds of articles and episodes of how that’s not really 50% after you factor in all the variables involved, but let’s, for argument’s sake, say it’s 50%.

Consider that one of the largest costs of providing you the services needed to run your practice is the fixed office space expense. Which, again, during a down market they’re touting, “Aren’t you glad you don’t have to pay that?”

But when the market is going up, which, again, historically over time happens more than it goes down, the opposite is occurring. Your firm gets the benefit of capping their costs because that is a big chunk of their fixed costs.

As you make more and more revenue for the firm, you’re still topped out perhaps at 50%. They don’t give you double the office size, they don’t give you double the health benefits. No, they get to benefit from the operating leverage of having those fixed costs. You keep generating more revenue for them, while their fixed costs stay relatively static.

This is one of the benefits of the RIA model. You control those fixed costs, and you can benefit from the operating leverage on the way up. So yes, it is fair to say, “When the market is going down, it’s not as ideal to have fixed costs.” But again, are you playing the long game here? Is it more likely that the market, for the balance of your career, will go up than it will down? And if so, you want to be the one to benefit from the operating leverage, not the firm you’re working for.

Finally, and this applies more to folks touting a wirehouse-to-wirehouse move is that a down market is a great time to recapitalize your personal balance sheet with a big bonus check by changing from one firm to another. “If the value of your deferred comp has gone down, or your 401(k) has gone down, this is a great time then to make a move and get another big bonus check and recapitalize your personal balance sheet.”

If having to make a move every 8, 9, 10 years going from one wirehouse to another is required for your personal financial planning for yourself, that you must get some big bonus check to fulfill your personal goals or fill in the gaps of your personal balance sheet, that’s not the way you want to do things.

If it makes sense for you and your clients to move from one firm to another or one affiliation model to another affiliation model, that is where your motivation should be. But if you find yourself having to make the move because your personal balance sheet is struggling, and you need extra capital coming in, I hate to say it, but you’re essentially selling your soul. That’s not a long-term strategy for yourself, your practice, or your clients.

It’s maybe a cold-caller, a recruiter that’s called you up and said, “Oh, wow, now’s a great time to get that big bonus check.” Again though, they are in the business of moving you from one firm to the other. I get it. They’re just doing their job. But you have to ask yourself, if that is your main motivation, is that a good long-term strategy?

By the way, and I’ve done a separate episode on this, and wrote a lot of articles, that big upfront bonus check is not what it seems when you consider the alternatives available to you. I won’t get into that here, but it’s something to be aware of.

I want to finish with some thoughts. I’ve been critical of different people’s motivations, and I’m rebutting what people are saying, so I did want to add my voice to the conversation, with some variables to consider.

The first thing I’d suggest you ask yourself is, is it business as usual for your practice? Over the past weeks, I’ve asked advisors I’m talking with how things are going with their practice, with their clients, considering the market.

And a lot of advisors tell me, “You know, it’s not really a big deal. We’re not hearing all that much from clients.” The reason is because they have long since ingrained in their clients, “We are investing for the long-term, markets will go up, they will go down. This is part of the cycle.” And as a result, their clients are not freaking out. Their clients are not concerned. Yeah, there might be a few more conversations than the norm, but it’s not a big influx.

If that is your situation, it’s business as usual, why should this alter a plan you might be putting in place to change firms or change affiliation models? If you have the right reasons to do it, the right motivations, if it’s business as usual, you should continue your planned path.

Related, I’ll use the term investment thesis. You hear this often by someone justifying buying into a particular company or mutual fund or whatever the case is. They have an investment thesis. I’m buying this stock because of these attributes, and what I think the future will bring for that.

If the market goes up or the market goes down, has your investment thesis changed? Whatever the reasons you bought that stock in the first place, does it still make sense to hold that stock, buy more of it, or whatever the case is?

How that relates to looking at different firm/affiliation options is, if it makes sense, which it does for many advisors, the better economics or better flexibility, whatever the case is, and if it is a fit for you, just because the market has gone down, has that changed your investment thesis?

If it’s business as usual with your clients, and your investment thesis hasn’t changed, why should you not continue the path and make a change with your practice? If your circumstances have changed for some reason, maybe you should take a pause. If it hasn’t, don’t let that trip you up on making a change if it’s better for you and your clients.

Next, be careful about the status quo.

I keep picking on W-2 firms or wirehouse firms, but it’s an easy contrast between a wirehouse firm and an RIA model. If you ignore what I just said about investment thesis and it being business as usual, and you say, “Well, I think I’m just going to hunker down and stay put for now. Maybe the status quo is a little safer for me and my practice right now.”

The reality is, if the market stays down for any reasonable amount of time, if you are at a large firm, particularly a large publicly traded firm, this will start to impact you. The shareholders of that firm are not going to simply accept lower profit margins, lower revenue, lower income. Yes, over the short-term, they don’t need to make knee-jerk decisions about how to cut costs immediately or increase revenues, or whatever the case is.

But if the market downturn extends they will start to make changes. They will either find ways to increase revenues (more cross-selling?) or they’ll start to squeeze you more on your payout, or maybe it’s more shared resources of sales associates. They will have to find a way to make up lost profits from when the market was higher.

So, don’t think the status quo is a safer alternative. If you were already frustrated by the service you were receiving, or the economics and the way your payout was being squeezed, don’t think that’s going to magically get better. It’s not. If the market is down and stays down for any period of time, they will have to make adjustments at some point.

And so the question is, if costs have to be adjusted, if revenue has to be reevaluated, whatever the variables, will you have more flexibility to control that outcome with your own practice under an RIA model – your own independent practice where you run the P&L – or are you comfortable relying on your existing firm and the existing shareholders to decide how that will be managed?

It’s going to impact you either way. Would you rather have more control and more flexibility over how to manage that, or would you rather let someone else do it for you? I’m sure you’ll agree that the do-it-for-you approach is not going to be in your best interest compared to the flexibility you could have to adapt better under your own independent model, your own RIA.

The final thing I want to comment about is to not use a down market as a reason to kick the can. If you’ve considered going into the RIA model, you’ve talked to someone like me, you understand the model, you understand the economics, the flexibility, what it will look like for your practice, and if it makes sense, it’s still very easy to come up with some reason to kick the can.

I’m often asked, what’s the number one thing stopping advisors from making a move to the RIA model? It’s easy, it’s inertia. It’s a lot of work. It’s a process. But when you come out on the other side, I’ve never heard any advisor say they regretted it and they wish they could go back. If anything, advisors say, “I wish I would have done it even sooner.”

And so, if you’re in that situation, you do want to make a move to the model, you do want the independence, the flexibility, the economics, there’s all kinds of excuses you can use. Even in up markets, people have excuses to push it out 6 months or 12 months. Many advisors never make the move at all. And maybe that’s fine for them. But it’s a shame if there’s a better path for them, if they know it’s a better path, they want to be on that path, and they use arbitrary reasons to kick the can instead.

If it’s business as usual, my investment thesis hasn’t changed, I know I’m going to get squeezed if I stay put, if you mentally say, “Well, I’m not going to make any move because it’s a down market,” and you don’t really have a further justification than that, I would challenge you and say you’re kicking the can. Will you ever make the move? If you’re going to use that kind of excuse, is there ever a time that you would make the move?

To show that I practice what I preach, I started my firm in the middle of COVID. There is no perfect time to be charting a new path. I left a corporate job with health benefits and a salary and all those things and decided, “I’m going to take the leap. I’m going to start my own business.”

I practice what I preach. I made that move. Yes, it’s scary. Yes, there are a lot of variables involved. But there’s no perfect time. I could have kicked that can and said, “Well, this is not a good time to be doing this because of COVID,” and then I would have put it off for who knows how long, and then there would always be some other excuse.

I realized if I’m going to make a move, if I’m going to start my own business, which is what I desired to do, I either do it or I don’t do it. If the reasons make sense, I either do it or I don’t do it.

There are many advisors that should not make a move under any circumstances. Up market, down market, it’s not a fit for them. Maybe they are already in the best place possible for their practice. I’m not giving the impression that everyone should make a change because that’s not the case.

What I am trying to say is, if it makes sense for you to do and you’ve done your homework, you’ve done your research, don’t just arbitrarily say, “Oh, well, the market is down so I’m not going to do it.” Make sure there’s a valid reason for why you do or do not proceed whether near-term or long-term.

With that, like I said, my name is Brad Wales with Transition To RIA. This is the sort of thing I help advisors understand. Does it make sense for you to make a move the RIA model? How does the RIA model work? What is the flexibility I keep hearing about? How would the economics work? And, by the way, if it is a down market, how do I control the expenses of my practice compared to the control I would or would not have now?

This is what I help advisors with all day long. These variables of the RIA model. I’m happy to have that conversation with you as well.

For starters, if you’re not already there, head to TransitionToRIA.com. You can find my entire episode series in video and podcast format, I have articles, I have whitepapers.

The easiest thing to do is at the top of every page, there’s a contact link. Click on that, you can instantly and easily schedule time to have a one-on-one conversation with me to talk about anything I’ve talked about in today’s episode or anything RIA related, in general. 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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