Q153 – What Are Red Flags To Look Out For In The RIA Model?

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Also available as podcast (Episode #153)

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What are red flags to look out for in the RIA model?

TL;DR – All affiliation models have pros and cons.  Unfortunately, all models have red flags to look out for as well. The RIA model is no exception. Whether it’s boastful promises of a 100% payout, undisclosed motivations for steering you down particular paths, etc. it’s important to be aware of, and recognize, when red flags are potentially part of the conversation.

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:

What are red flags to look out for in the RIA model? That is today’s question on the Transition To RIA question & answer series. It is episode #153.

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. There’s a Vendor Profile Series. All kinds of things to help you better understand the RIA model.

Again, TransitionToRIA.com.

On today’s episode we are going to talk about potential red flags to look out for in the RIA model.

If you have followed me along on many of these episodes, whether on video or podcast, you know I’m a straight shooter. I always believe that if there’s a second side of the coin that needs to be explained that that needs to be part of the conversation. I don’t hold back.

As I often say, the RIA model, just like any affiliation model, has pros and cons, and you want to understand what those pros and cons are. So I want to talk about some of the red flags to look for in the RIA model, or in the marketplace of folks talking about the RIA model.

Again, to make sure you’re seeing both sides of the coin on this.

Now, I would point out, other affiliation models not only have red flags as well, but generally a lot more red flags. Whether you realize them or not, perhaps because you’ve been in only one firm, or one affiliation model your entire career. You’re perhaps not even realizing that things that are occurring are arguably red flags you should be recognizing in comparison to other pathways in the model.

I discuss a lot about the arguably downsides of the wirehouse model and some of the other affiliation models in the marketplace. So those red flags exist as well. But again, to be fair, let’s discuss some of the red flags in the RIA model as well.

I want to go over a couple of them with you on this episode. But this is not an exhaustive list of every possible thing you should consider when evaluating the RIA model. Again, a big part of what I do is helping you understand all these variables, and understand all the decisions, all the things you should be paying attention to when considering the RIA model for your practice. I’m happy to have that conversation with you as well.

Let’s dive into a couple of them.

First, you will hear folks that are proponents of the RIA model, which arguably I would like to, not to pad my ego, to say I am one of the biggest proponents of the RIA model in the entire industry – I’m now up over 150 episodes talking about how the RIA model works – so clearly I’m a proponent of the model.

Again though, the model is not for everyone. I don’t believe it is right for everyone. What I do believe though, is advisors owe it themselves to at least take the time to understand how it works, how it would look for their practice, what they may or may not gain by going to the RIA model. That’s again what I help advisors with.

Even though I’m a big proponent of the model, one line you generally won’t hear me ever say, but there are proponents in the industry that part of their pitch is that there is a 100% payout.

You will see that in marketing pieces, advertising pieces, voices up on industry conference stages perhaps, and they’re talking about how you should go RIA because it’s 100% payout.

What they are referring to in that regard is having your own RIA where you essentially retain 100% payout.

Now, this is semantics, but I would start by pointing out if you have your own RIA, it’s not even a payout to begin with. What they’re referring to is that you keep 100% of the fees you charge your clients.

And so how that logistically works is you enter into an advisory relationship with a client. You agree to what the fee is going to be that the client is going to pay you.

Typically, the predominant way done in our industry is an AUM fee, generally done on a prorated quarterly basis. Although we’re seeing more folks do it monthly.

But the idea being it’s this AUM fee that’s debited out of client accounts.

That process is typically done through technology. Once a quarter, the custodian is notified by the RIA… “here’s all of our client accounts, here’s how much fee each of those accounts owes us for our pro-rated fee.”

The custodian does the debit out of all those accounts and remits 100% of that fee to the RIA. That’s typically what these folks are referring to. They say 100% payout, but it’s not a payout at all. It’s not going through the custodian’s P&L. It’s not considered revenue for them that then they are paying out at 100%.

The custodian, essentially for convenience to you and the client, is just helping you facilitate the payment of the fee. The client in theory could write you a check directly for your fee. You don’t have to debit it out of account, but that’s just traditionally how it’s done.

So there is no payout with your own RIA. You are just receiving 100% of the fee you charge your clients, which is how it should work with a business, right? You have any kind of business, you have a price on a product or price on a service, you are paid 100% of that.

Now, it’s not the misuse of the word “payout” that I’m lamenting about, even though I don’t think that should be used for all the reasons I just explained. But what I think is a bit disingenuous is the way it’s expressed of… “you should go the RIA route, start your own RIA and get 100% payout.” Because it implies that, as if 100% is going to flow to the bottom line and into your pocket, which is absolutely not the case.

If you have your own RIA, yes, 100% of your client fee – it’s your fee that you’re charging the client – yes, you get to receive 100% of it. However, there are costs involved with running the RIA and making it possible for you to provide that value and services to clients in return for the fee you’re charging them.

So yes, 100% flows to the top line, but then you have a series of expenses needed to run a modern day RIA. So the bigger question you’d want to ask yourself is… “Yes, 100% goes to the top line, but by the time I build out all these solutions, how much actually flows into my pocket at the end of the day?”

I’ve done separate episodes on how the economics of the RIA model typically look. It’s beyond the scope of this episode. I don’t want to get too sidetracked with that. You can check that out separately. And of course, I’m happy to have a conversation with you directly about it.

But the idea being, just be careful with anyone whose opening line, or they’re very loud and proud to talk about 100% payouts. Again, devil’s in the details. That’s the top line number. At the end of the day, what really matters is what the bottom line number is.

So, that’s red flag number one. Anyone that’s touting 100% payouts, just question why that’s what they’re leading with and not providing you the bigger scope that goes into that.

Next, this one is applicable to any kind of affiliation model.

But if you join an RIA, and there’s plenty of reasons that might be the path you decide to go on, that’s a big part of what I help advisors understand is should you start your own RIA, should you join an RIA, there’s actually a flavor in the middle of that as well. But if we conclude after you’ve taken the time to understand how all those options work that joining an RIA is your best path, well, there’s a lot of different flavors out there of RIAs, some that you will have no interest in because what you want to do with your practice and career going forward is not going to align with their value problem. And there’s others that you could find very attractive.

But anytime you’re joining a firm, and this is the same if you’re changing to another wirehouse or changing to an independent broker-dealer, is what are they having you sign? There always is some sort of contract, or agreement, whatever we want to call it, that you would be signing off on and it’s no different in the RIA space and you want to be careful of what you’re signing.

Just because it’s the RIA space – and this is where the future of the industry is going; it’s the fastest growing part of the industry – doesn’t mean there’s perhaps some bad actors out there, folks that are having you sign to certain terms that is not what your impression was.

Now, I don’t paint a broad brushstroke and say that anyone that has you sign something is up to no good because every firm will have you sign something. Even vendors with your own, you have to sign something whether it’s with a custodian or a compliance provider, technology providers, etc.

So to merely sign something is not the problem. But just be careful with language that might be in agreements. I have seen folks get burned – which is perhaps a tough word to describe it – but they come to me, they hadn’t utilized me to help them find the RIA they’re with currently, and it turns out it’s not what they thought it would be. And now when they go to try to leave, there’s some more hurdles to that that could be prohibitive or make that very difficult, could have significant economic implications for them.

And so you want to understand the different value props in the marketplace and make sure that the one that you’re perhaps going to join aligns with what you want to accomplish and what you need for your practice and that the language that they’re going to have you sign matches what your expectation is.

Not to give you a sales pitch but that’s a big part of what I help you with is make sure you’re understanding all that on the front end. Catching that before you’re in a position of having to sign off on something.

But I have seen some situations that were not ideal from advisors after the fact. Again, where they’ve come to me and they’re saying…. “Years ago I joined this RIA, and here I am, it’s not what I thought it would be, what are my options?”

But again, you can have that challenge (signing agreements) with all the affiliation models. But it’s just important to really slow down, take the time to understand what you’re signing before you do so. It’s no different in the RIA model than it is in other affiliation channels.

Next, another red flag, and this is a tough one because there’s some wonderful people in our industry. But many of them have changed jobs over time, and have changed who they work for over time, and have changed what kind of model they’re perhaps in.

I’ve evolved my own career over time as well. I get where your interests can change as perhaps an employee somewhere. Your career progression could change.

But it’s interesting because I see folks out there that – in this case, we’re looking at red flags of the RIA model – that are now these giant proponents perhaps of the RIA model, but in their prior job, they were giant proponents of something exactly opposite from the RIA model. Maybe it was the wirehouse model. And you just have to pause.

Again, these folks, particularly business development folks, sales folks, it’s fair, they are doing their job, they are hired to position a particular platform or custodian or whatever the case is. But you sometimes wonder, two years ago, perhaps they were at an entirely different model and they were loud and proud to talk about how that is the superior model for advisors, and that the RIA model was some sort of inferior model.

And now for whatever reason, circumstances have changed, they’re now with a straight face telling you that RIA model is the better fit.

Now, they might simply have seen the light. They might have realized, wow, what I had before, what I thought was the better model, because maybe that’s the only model they were ever in their entire career. And then they saw the light. They took the time to learn more about the RIA model. They went, as they say, where the puck is going. And it’s fair for them to flip that switch, if you will.

But I think it’s also fair just to understand someone’s motives and say…. “Is this because you truly believe in what you are selling, what you are pitching? Or is this just because it benefits your career?”

Again, I’ve seen this with folks touting the RIA model in general. I’ve seen this with folks touting specific RIAs you could join. I’ve seen it with folks at custodians where even custodians have different value propositions. Individuals were at a different custodian prior that had a particular value proposition. And for 10+ years, that’s what they were touting was the superior way to work with a custodian. And now all of sudden they’re at a custodian that has an entirely different value proposition. And again, with a straight face, they’re telling you that’s the superior way to work with a custodian.

Again, perhaps they’ve evolved, perhaps they genuinely feel that and that’s what caused them to change firms and they proactively did that. But you have to sometimes just take a pause and ask… “walk me through why you feel this is the superior way that you’re telling me?” Whether it’s a custodian, or an RIA, or the RIA model in general.

Now some people might say…. “Brad, aren’t you in that boat as well?”

I worked at a multi-channel firm for about 20 years before launching my own firm. And that multi-channel firm, by definition, multi-channel, had employee channel, independent brokerage channel, had RIA channel. I spent the bulk of my time there in different roles in the RIA channel. And so my career progressed with the RIA model in mind because I was a believer in what that channel stood for. And then I finally took the step now almost six years ago of launching my own firm because the RIA model is what I believe in and this is where the industry’s going and to help advisors with it.

I don’t want to demean anyone that has pivoted their careers, but take the time to understand just because someone tells you it’s a superior model, let’s make sure what their motives are or why they genuinely feel that way or not.

So that’s a red flag to point out.

Another red flag, and again, this is not an exhaustive list, is something I’m not a fan of at all. I’ve ranted about this in several episodes. I think it is a giant red flag.

A question that’s often asked, and I’ve done episodes on this, I’ve been asked about this on conference panels, I’ve been asked about this from reporters for articles, the question is… how big do you need to be as an advisor, as a team, before you have your own RIA?

Anyone that gives you an instant answer to that question with a specific number, generally that’s a giant red flag. Generally they have an agenda behind that answer.

I did a whole separate episode on this, so I’m not going to rant too much here – you can check out that other episode of all the variables that go into where it might make more sense or not to have your own RIA at a certain size – but the reason I say it’s a red flag is because oftentimes people that answer that so quickly, have an agenda behind it.

Let me give you an example of what I mean by that. And this applies to custodians, this applies to platform providers, it applies to RIAs you could join. Where typically these solutions have certain minimum sizes to be able to utilize their services

As an example, let’s pick on custodians.

If you go to a custodian – by the way there’s all kinds of variables that go into how you should select a custodian; I did a whole episode on how best to choose a custodian; it’s a big part of what I do is help an advisor understand that; I’m happy to chat with you about that as well – but many custodians have minimums and you must be a certain size to be able to use them for custodial services.

And so if you go to them, and their policies say they’re not able to do a custodial agreement with a team of your size, well, their default answer might be…. “You’re definitely not big enough to have your own RIA. You should definitely plug into an RIA. That’s going to be your better path.”

And perhaps you should be joining an RIA. Again, like I said, there are multiple pathways into the model. It does make sense for many advisors, many teams, to join an RIA. I help a lot of advisors down that path. But you want to make sure the reason that’s being suggested to you is because it’s based on your practice and what you’re trying to accomplish and what your needs and desires are. Not because they wouldn’t be able to help you otherwise.

I’ve also seen that with platform providers. Again, they have a certain size minimum. You go to them and say… “Can I use your platform services?” Well, if you’re below their minimums, again, they can’t help you. So what do they tell you? Sometimes very quickly…. “No, you’re too small to have your own RIA. You should join one of the RIAs that’s already using our platform.”

Again, maybe reasons to do that, but you also have to question, are they just doing that because otherwise they wouldn’t be able to possibly earn your business.

Now I don’t want to suggest that all the folks out there, and all these different wonderful solutions are nefarious in that regard. Most of them are very good, very experienced and will help you consider your options and think things through.

But like I said, by definition of the title of this episode, the red flag is someone that comes out with a very quick answer to… am I large enough? You go and tell them how big your practice is, and someone gives you that immediate answer, yes or no for that matter. Typically, that’s a red flag.

You should at least hit pause and say, why do you feel that way? What are the reasons I should consider agreeing with you or not on that and perhaps do they have motives that might be incentivized to answer a particular way.

Because I help advisors down all three paths, again, start your own, or join an RIA, there’s a flavor in the middle, I don’t have any incentive one way or the other to be trying to steer you down one path versus the other. I can help you down all three. My objective is just to help you understand how all three work. They all have pros and cons. All affiliation models in the industry have pros and cons.

I just want to help you understand how they work, help you determine which path is best for you, not because of some arbitrary line in the sand about what size can or can’t be helped, or what size particular solution can or cannot help you.

So that’s just a red flag to look for as well.

And then to wrap up, and like I said, this is not an exhaustive list, but one almost counter point here, which I would put in the red flag bucket.

I’m sure if you’re a tenured advisor, you get blitzed all day long by recruiters trying to reach out and essentially pitch their firm, pitch their offering, whatever solution it is. That’s just part of how the business works is that you have folks doing this.

If it’s someone coming from the RIA model, perhaps an RIA that’d like to have you join, or a custodian, understandably they’re going to talk about the RIA model in that regard.

Or if a branch manager from a wirehouse is calling you, they’re going to be talking about a wirehouse.

Just careful though with, and I’m not painting a broad brush and suggesting all independent third party recruiters are like this, but from a red flag perspective, just know there’s several reasons it’s often easier and arguably more economically advantageous for third-party recruiters that are cold calling you to try to steer you into something other than the RIA model.

Perhaps that’s to another wirehouse if you’re at a wirehouse now. Or maybe to an independent broker-dealer.

There are a couple reasons they might try steering you that way.

One, they just oftentimes don’t have the skill and experience and network to be able to help you figure out the RIA model like I’m able to. So one, they just can’t do it because they simply can’t explain it or be a good resource for you on that. So they go to what they’re used to.

And then it is what it is, the model with third party recruiters, the independent recruiting firms, in many instances, not all, but in many instances, those firms are paid, or can be paid, sometimes significantly more for steering you to a, for instance, wirehouse solution or independent broker-dealer solution, then they can steer you to the RIA model.

I sometimes joke I’m maybe not the smartest person alive because here I am, I guess I should just be selling my soul and just trying to steer folks to go the wirehouse model, but that’s 100% not what I do.

I’m a believer in the RIA model. That’s where I help advisors down.

But just know there’s an economic incentive for many of these folks to be suggesting paths that are not the RIA model. Again, because either they’re not familiar with it or quite frankly in some cases they’ll get paid double, we’re now even near close to triple what they could make steering you towards one of these more captive firms, than they could perhaps helping you go down the RIA path.

It is what it is. You could say, well, no, they’re not letting that impact their decision process. You just need to make a judgment. If someone’s only suggesting one route that’s not the RIA model, ask yourself, is that because they have a potentially significant economic reason for trying to suggest some other path is better for you than the RIA model.

I’m not suggesting that the RIA model is best for everyone. It’s not. And there are some of you that should not be going down the RIA path. And those folks, those recruiters are potentially helping you down the right path. But just know at a high level, there’s some incentive for some of these folks, a red flag, if you will, to steer you one way versus the RIA path because it’s significantly more advantageous for them, as a third party recruiter. So I’m going to put that in the red flag camp as well.

And then to wrap up, and not to make this into a sales pitch for me, but anytime you have a situation where there could be red flags – and you do the same thing with trying to help your clients avoid red flags as well – there are a lot of moving parts in this industry. There are a lot of different paths with the RIA model. There are lot of different ways to go into the RIA model. A lot of different platforms and firms and solutions and decisions that have to go into that.

You don’t need to be intimidated by that. There are some wonderful people at each of these solutions that will help you understand their particular solutions. But it helps, again, not to make a blatant sales pitch, but knowing there’s so many moving parts, it helps you to work with someone like me that will help you navigate them, make sure you’re not blinded and missing some possible pathways, perhaps that you’re not even aware of.

Just because you’ve talked to one firm, or one solution, you might assume that’s the only way to go about doing things and maybe those ultimately are going to be the best paths for you. But maybe there are other pathways you’re not even aware of, or firms or solutions that you should be considering as well.

You want someone that understands all this, that’s been doing this for 20+ years to help you navigate that. And again, I’m all in on the RIA space. If you’re at a wirehouse and want to explore another wirehouse, I literally cannot help you. I do not do that line of work. I only help folks consider the RIA model, understand the RIA model, and if it makes sense, how to navigate a transition of their practice to the RIA model. I’m happy to help you with that as well.

First things first though, head to TransitionToRIA.com where you’ll find this entire series in video format, podcast format. There are articles, there are whitepapers. There is a Vendor Profile Series.

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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