Q150 – What Are The Pros And Cons Of The RIA Model?

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Also available as podcast (Episode #150)

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What are the pros and cons of the RIA model?

TL;DR – There is no golden goose. There are pros and cons to the wirehouse model. There are pros and cons to the independent broker-dealer model. There are pros and cons to the RIA model. What’s important is understanding what those pros and cons are, how they compare to your current situation, and whether they justify transitioning to a new model.

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 the pros and cons of the RIA model? That is today’s question on the Transition To RIA question and answer series. It is episode #150.

Hi, I’m Brad Wales from 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 model.

Again, TransitionToRIA.com.

Today’s episode is a pretty meaty topic… what are the pros and cons of transitioning your practice into the RIA model?

This is episode #150, so I figured for a nice round milestone episode, it deserved a good meaty-sized topic. But as a result, there’s a lot to cover here, and so I’m only going to go into some of these topics at a high level. But it is to give you at least an initial understanding of what the pros and cons are of a potential transition of your practice to the model.

And the reason I’m pointing out the pros and cons is I am a big believer that you need to understand both sides of the coin. Every model in the industry has pros and cons.

There are pros and cons to wherever you are now. There are pros and cons to staying wherever you are now. There are pros and cons to the wirehouse model. There are pros and cons to the independent broker-dealer model. There are pros and cons to the RIA model.

There is no golden goose. Anyone that ever gives you the impression about whatever model you’re in, including your current firm, gives you the impression that that is the best solution in every way possible, and there are no cons to weigh those pros against, is either ill-informed or is being disingenuous. Again, there’s no golden goose.

What you want to do is make sure you understand what these pros and cons are, compare them to the pros and cons of what you have now, and ultimately say… would making some sort of change put me in a better place?

So with that, I want to give you some high-level pros and cons of the RIA model. This is not an exhaustive list, but it will give you plenty of things to be thinking about.

On the pro side, generally speaking, and I’m going to give you several examples here, but generally speaking, all the different pros that we could talk about fall into one of two buckets. And those buckets are either a desire for better economics that you’re hoping to achieve by going to the RIA model, or better flexibility with your practice. I’ll give you examples of both of those.

Higher Income

On the better economics standpoint, and these are not necessarily in any particular order, the first one is higher income.

Generally speaking, for reasons you’ll see as we keep working through this list, the income you can derive as a financial advisor, in most all scenarios, is going to be higher in the RIA model.

Now, that comes with responsibilities which we’ll get to, but the income generally is higher particularly if you are currently at a wirehouse firm, where you are giving the lion’s share of your revenue to your firm. Now your firm is providing you some value for that, but we could look at the economics and say… are you getting your money’s worth for that?

And so when you compare the bottom line, and the bottom line is not everything in this world, but it is what it is, when you compare the bottom line of being an advisor in these different affiliation type models, it generally is always higher income in the RIA space.

So just as a starting point, that is a pro to be considered.

Control local expenses

Next, one of the ways you derive a higher income is because in the RIA model if either you have your own RIA or you’re in a 1099 affiliation with an existing RIA – which I’ve done all kinds of episodes on why you might want to join an RIA versus starting your own – you will control your so-called local expenses.

You have control over the size and location of your office. You have control over the size and members of your team and what they’re responsible for and how much you’re going to pay them. You have control over all those variables.

As a result, you only pay for exactly what you need and nothing more than what you need. One of the ways to drive your bottom line higher is to have control over that.

Higher enterprise value

Next, again from an economic standpoint, in almost every instance, you also will have a higher enterprise value attributed to your practice if you’re in the RIA model.

If you’re at, to again pick on wirehouses, if you’re at a wirehouse and you ride out your career and you go through, they’re often informally referred to as sunset programs at the firm, the valuation typically attributed to your practice under those circumstances is almost always less then you can get in the open marketplace, in the RIA model.

There are several reasons for why that is. I did an episode on why your enterprise value is generally better in the RIA space. So if you want to do a deep dive on that, check out that episode.

But it is what it is. Enterprise value is generally better in the RIA space and as I’ll refer to in a moment, so is the taxation on your eventual liquidity event when you do go through a succession.

Real estate

Next, another big pro on the economic side, and this relates to being able to control your local expenses, is your ability to control your real estate.

Now, in some ways, that’s beneficial because if you were going to lease an office, perhaps you only need to lease the size office that you ultimately need and nothing bigger than that. Or because you get to choose the location of the office, you could have a lower cost office if you wanted, then perhaps otherwise would be provided for you at a wirehouse, which you’re paying big bucks for.

But one of the huge benefits of having your own RIA or being 1099 of an existing RIA is long term also your ability to potentially acquire the building that you will have your practice in.

Some RIAs are entirely virtual, but to degree you want an office footprint, you are going to be paying for that one way or the other.

If you’re at a wirehouse now, you are paying for the office they are providing for you. Now, you don’t get an itemized bill that shows you what that line is, but that is part of the payout retention they are keeping. So you’re paying for it.

If you were in the RIA space, to the degree it makes sense for your location and your economics and what your long-term vision is, if you can acquire the building you’re in, and over the balance of your career, which for some of you could be 10, 15, 20 years or more, as opposed to paying for an office via your payout, never to see another dime of that, or even leasing a space, if you could acquire something, you’re essentially paying yourself and alongside building the enterprise value in your practice, also be building value in this asset that at the end of your career, you’ll be able to sell that as well.

That’s a huge benefit you simply do not have in the W2 world. In the RIA space, when you’re independent, you have the ability to potentially acquire an asset, a building alongside just the value of your practice.

Better taxation

Then to wrap up economics, again, this is not an exhaustive list. I briefly mentioned having better taxation with your own RIA, or being 1099 in the RIA space.

Whether that’s taxation on what you can write off in your expenses on your P&L, and being able to control your local expenses. Or if you do acquire a building and perhaps depreciate the asset and how you structure that and be able to offset income otherwise.

Another example, as I alluded to with enterprise value, is how you one day exit the practice. It’s not just the valuation you receive for your life’s work on the way out, it’s also how those proceeds are taxed.

In the RIA space, the independent space, you generally can structure that so it’s mostly taxed at long-term capital gains tax rates. If you exit under the W2 type world, you’re generally taxed at typical income tax rates, which for some of you could be double what the tax rates would be for long-term capital gains tax rates.

Better taxation is another big pro in the economic bucket.

Service offering

Now, we’ll move on to flexibility. As we said, the main two buckets on the pros, economics and flexibility.

On the flexibility front, and these are in no particular order, but just to give you some of these variables, is the ability to have flexibility with the services you offer your clients,

As the industry continues to evolve, and as this so-called theme of fee compression continues to evolve, the idea is what services do you provide for your clients?

For many of you, that’s at least asset management, oftentimes it’s also financial planning. But as you’re going to the RIA space, your ability to complement that with additional services, maybe family office style services or auxiliary services that you can offer alongside that, you have more flexibility with what your service offering is in the RIA space.

You generally have very limited ability to control that in the more captive environment. There are certain things you can or can’t do, take it or leave it, no flexibility beyond that.

In the RIA space there is much more flexibility with the services you can offer.

Investment solutions

Similar, in the RIA space you generally have much more flexibility with the investment solutions you can use with your clients.

If you’re at, again, that proverbial wirehouse, they’re the gatekeeper. Literally that’s the term often used. The firm’s gatekeeper decides what SMA managers are available for you to use. The gatekeeper decides what mutual funds you’re allowed to use, or ETFs you’re allowed to use.

In the RIA space, particularly if you have your own RIA, you can generally use whatever you want. Now, there’s work that goes into sorting through what might be a good solution or not. But that option set is always going to be bigger for you in the RIA space than it is in some sort of captive environment where they have narrowed the field, that gatekeeper has put those guardrails in place.

You’re going to have more investment solution options in the RIA space, again, than you do in that captive world.

Marketing

Another big motivator for a lot of advisors that want to move into the RIA space is more flexibility with how you can market your practice and market your services.

A lot of times if you’re in a captive space, it’s very restricted in how you can establish a brand. Generally you can’t in that captive space.

Being able to establish a brand, being able to use different marketing techniques, whether you want to have a podcast, or make videos, or make whitepapers, or articles or blogs, or appear on the radio, or whatever the case is, in the RIA space, you have the flexibility to do all that.

Now, does that make sense for you to do all of those? Perhaps not. Do you desire to do all of those? Perhaps not. But you must understand there’s advisors in the RIA space that have the availability to do all of that. And if you don’t have the flexibility to do that currently, you are at a disadvantage in the marketplace. An advisor likely local to you is able to market their services with more flexibility than you have.

So that’s another big pro on the flexibility front is how you can do your business development, how you can market your services.

Building your team

Another example on flexibilities, and this goes back to the local expenses, is how you build out your team. What type of roles you want to have on your team, and specifically who you want to have on your team.

With your own RIA, or 1099 RIA arrangement, there is no asking someone’s permission to add to your team, or you might want to hire someone but maybe that decision is ultimately up to someone else.

In the RIA space you decide all that. Now, you have to manage that responsibility as well. If you over hire and you have a pretty bloated team that’s going to impact your bottom line. But you have the flexibility to decide exactly what that will be.

Maybe you want to have two full-time people and one half-time person. Well, if that makes sense for you and it makes sense for the people you want on the team, you can do that.

Again, you’re not asking anyone’s permission of how to build out your team.

Office arrangement

Another big pro on the flexibility front, and this comes back to the real estate, is you get to decide what your office looks like and where it’s located.

If you’re at a captive environment now, yes, they are providing you some sort of branch office, and there’s some pros to that, they’re providing it for you. But maybe that’s not a convenient location for you, or a convenient location for your clients, or maybe you need more space, maybe you want a different kind of space. For instance, now with technology evolving and doing more things by Zoom and maybe there’s better ways to set up the office or the conference room, you have more flexibility with that in the RIA space.

Technology

And then the final example on the flexibility front, and again, this is just some examples, there’s plenty more we could dive into, but similar to the office flexibility is also your flexibility with technology.

In the RIA space, you can choose from amongst the hundreds of fintech solutions that are out there. Now that also comes with its own challenges, because you must sort through that and make decisions.

But you have the ability, if you find some technology that you like, and it makes sense for your practice from an integration or cost perspective or whatever the case is, but if it’s a fit you’re not asking someone’s permission. You can just do it and implement it into your practice.

And over the coming years, that’s going to become increasingly important to have that flexibility, particularly as AI tools keep coming out. As it seems like new tools are coming out literally every week.

If you’re at some big giant firm and they have this very slow dinosaur review and approval process for any technology that comes along for either them to create it themselves or if you wanted to use some third party tech but you have to wait for them to sign off on it, that can be very cumbersome and by the time they’ve finally approved something the way AI is evolving, there’s something maybe already more impressive out there that now you got to start the process all over again.

So just know much more flexibility with the technology you desire to use in the RIA space.

Very high level, those are some of the meatier, bigger pros involved with the RIA model.

Now let’s talk cons, because again, there’s two sides to the coin. As much as I’ll talk about all the great things, you also must know what are some of the cons.

More responsibility

First, I always point out whether you’re your own RIA or joining as a 1099 of an existing RIA, that comes with more responsibility.

Everything I’ve been talking about is all good, but that also comes with more decisions you need to make.

For instance, we can talk about how you have the wide open world of technology, the whole landscape to choose from. Well, guess what? That’s more decisions you need to make.

For better or worse, if you go to a wirehouse firm, they’ve given you the technology that generally you must use. That’s it. Here it is. For better or worse, that’s one decision.

If you’re in the RIA space, yes, you have the pro of those additional options, you also have the responsibility of deciding which of those to potentially put into place. So to be fair, there are more decisions that come along with all of that flexibility as well.

Now, to the degree some of that still seems a little daunting to you, that’s a big part of the value prop of RIAs you could join. And again, that’s a whole different topic. I’ve done several episodes on why you may or may not join an RIA.

But part of the value prop of RIAs you could join is they’ve gone out there and they’ve said, hey, we’ve made the bulk of the behind the scenes decisions for you on some of these pieces. You still get all the flexibility on your local expenses and all that, but we’ve put together some of the blue chip, best in breed solutions. We’ve already done the due diligence. We’ve made those decisions for you. Here’s what it looks like. We’d love to talk with you about it. We’d love to have you come use our platform.

So to the degree you don’t want wide open all the decisions to have to make yourself, there are often referred to as “bundled solution providers” that have put a lot of that together for you. Obviously your due diligence would be on looking at that, what they’ve put together and say, do I like what they have? Or maybe there’s another firm you could compare it to and decide which one you like better.

But nonetheless, there are more decisions that go into it when you have more flexibility.

Another example of additional responsibility is, back to controlling your local expenses.

Yes, it’s nice to be able to build out your team and decide who’s going to be on the team and what you’re going to pay people and who you’re going to hire, who you’re going to fire…. but guess what, that’s more responsibility than you likewise have now.

Now, it’s generally better to have the flexibility with all that, but when it comes time to have to go out and find people or fire people – there are resources that you lean on to help you with those sorts of things – but that is an additional responsibility to manage your local expenses, whether it’s your team members or the office arrangement.

Again, more flexibility, but more responsibility to match as well.

Compliance

And then the final responsibility, and this is certainly the case if you’re starting your own RIA, you are now on the front lines of managing your own compliance.

Everyone, no matter what model you’re in, no matter what firm you’re in, you’re already adhering to some level of compliance responsibility. If you have your own RIA, you are the front line. You are responsible for managing the regulatory responsibilities, the compliance responsibilities of that RIA.

Now, there is a whole ecosystem out there to support you and help you manage that responsibility. I’ve done episodes on how that process works. I’m happy to talk to you about that. So do not be intimidated by it. But for anyone that’s not currently in the RIA model, that’s generally a new responsibility you would have.

But again, it also comes with flexibility of how you implement regulations, how it impacts your policies and procedures and the way you go about doing things in your practice.

So there’s a lot more flexibility, but to be fair, that comes with a responsibility. But again, there are solution providers in the marketplace that help you manage that responsibility. So do not fear it, but that is an additional responsibility.

Transitioning your practice

We can go through all these pros, how the pros outweigh the cons, how maybe this new path over here is a lot better than what you have now. However, to get from point A to point B requires a transition. And a transition is a lot of work, measured not in weeks, measured in many, many, many months. Sometimes planning even starts years in advance.

So no matter how more green the grass is, there are advisors that know they’ll be better off, they know they’ll be better off for the balance of their career, they know they’ll be better off when they go to sell their practice from an economic standpoint and take care of their clients, take care of their team members, but they just can’t bring themselves to go through the trenches, to go through a transition.

Yes, there’s a well-established process for how to go through a transition. There are solution providers that help you through the transition. I guide you through the transition. But it is still going to be a lot of work on your part. There is no way to avoid it.

But the idea being the additional work is finite. Once you get on the other side, once the dust settles, once you’re in this better environment, advisors always look back and I’ve never heard advisors say, it wasn’t worth going through the trenches to come out on the other side.

But to be fair, one of the cons, if you will, of transitioning your practice to the RIA model is you would need to go through a transition. So part of your exercise is to say… What would I gain from doing this? What are the pros? Yes, let me understand the responsibilities. Let me compare that to the pros, cons, and responsibilities I have now, and is the delta in what I would gain from doing that, is that worth going through a transition?

For some advisors, it’s not. For different reasons they might conclude it’s not. Or they just might not ever be able to bring themselves to do it no matter how much they realize it is the right decision.

My job is to help make sure you at least understand how all this works so you can make an educated decision. And ultimately, you have to decide whether you’re going to cross the bridge or not.

Myths

I want to finish briefly here with a couple cons that are actually myths.

The list of cons I gave you wasn’t an exhaustive list per se, but there’s also a lot of seemingly cons that are communicated about the RIA model that are inaccurate, are now myths, that are often peddled by people that are trying to keep you from maybe exploring a different path.

They’re trying to keep you at your firm, they say these things about the RIA model either because they are ill-informed themselves, they simply do not know, perhaps because your branch manager or whoever’s saying it has only ever been in one model their whole career, or maybe even only one firm their whole career, so they oftentimes simply don’t even know how it works in the RIA space.

They’ll just say things naively at times, or they have an ulterior motive. They don’t want you to leave their current firm or their current branch, so they will say things to try to talk you out of it.

So I want to give a couple quick ones just to know that these are falsehoods and to not put any weight to them.

First, and this is the oldest one, thank goodness, you don’t really hear this one as much anymore because it’s such a tired, lame, pathetic explanation for why you shouldn’t go to the RIA space. But the old saying was… “the people that go to the RIA model are just the advisors that can’t cut it in the wirehouse world.”

There might have been a time decades ago, decades ago, where there was maybe some validity to that. That is no longer the case at all. If you look at the caliber and size of teams that are moving out of that captive world into the RIA space, to suggest that these highly successful people – oftentimes folks that are significantly more successful than the people that are passing along this falsehood – to say that only people that can’t cut it in the wirehouse world, those days are numbered. The 1970s called and wants the tired old excuse back.

Anyone that’s still peddling that excuse is literally either stuck in the past or just naive to how the model has evolved. Don’t listen to that at all if you hear that.

Another so-called “con” is that your clients insist on having a big firm name behind you.

There was a time there was maybe some more weight to that. Back during the ‘08-‘09 crash, a lot of that goodwill got wiped away and it’s never come back.

For clients nowadays, the most important thing is the advisor, the relationship with the advisor. That’s why they’re choosing to do business with you is not because of the name on the side of the building. It’s because of you, the trust they have in you, the value you provide for you. They’re doing business with you, not the name on the side of the building.

So to suggest that you couldn’t go into the RIA model because your clients want to still work with this big name firm, again, that’s how it was maybe back in the day. That’s not the world we live in nowadays.

But even to the degree you feel that (a big firm name) still could resonate with some of your clients, keep in mind, I won’t go too far into this, it’s a whole different topic, but as an RIA you will be using a custodian to hold your client assets.

I’ve done episodes on how to choose a custodian, how custodians generate revenue, all kinds of things.

But the main thing, keep in mind, there are some very big name firms, well-known firms that you would use as your custodian that will safeguard and hold your clients’ assets. These firms have trillions, with a T, trillions in client assets held in custody.

To the degree that is something still important to your clients, you can choose a custodian that will have a name that they are very well familiar with, that they have a very high regard for.

So don’t think that the name on the side of the building is a reason you should or shouldn’t be considering the RIA model.

Two final myths, if you will.

There are also people that are still holding on to saying… “the technology in the RIA space is inferior.”

No, it’s actually 180 degrees opposite of that nowadays. I did a whole episode on how RIA technology compares to broker-dealer technology, so check that out if you want a deeper dive.

There was a time where wirehouse, captive firm technology was arguably better than what was in the RIA space. That has now, again, changed 180 degrees both from the value that the technology provides you, and the choice of technology solutions to choose from. It is better in the RIA space than it is in that captive W2 world.

Again, check out that whole separate episode if you want a deeper dive on why I say that. But but don’t let anyone suggest to you that the technology is not as good.

Then, the final “con” myth I’ll note is that you’ll have less investment solutions to use with your clients.

Some attempt to argue, for example, that you won’t be able to offer as many money managers as you have access to at a big captive firm.

There was a time there was arguably some truth to that. No longer the case at all. You would be hard pressed to find any type of service or resource you have available to you now in that captive environment that you use with your clients, that is not only not available in some capacity in the RIA space, but generally comes with more options to choose from and at times simply better solutions to choose from.

So don’t let anyone suggest that you’re not going to have these resources. And that applies to servicing high net worth and ultra high net worth clients. The RIA ecosystem has evolved tremendously to be able to support those type of clients. 20 years ago that was not the case. That is the case today.

Don’t let anyone suggest that you have the type of clients that only can be serviced at large captive firms and it can’t be done in the RIA space. 100% incorrect on that front.

To wrap up, what I’ll leave you with, again, these are some high level pros, high level cons. Recognize there is no golden goose. You want to look in the mirror and say… “What do I like about my current firm? What do I not like about my current firm? What would the RIA model look like for my practice specifically? What are the pros? What are the cons? What are those additional responsibilities? Does that make sense for me? Do the pros outweigh the cons? And collectively, is that better than what I have now?”

It’s a good exercise. All advisors and teams, regardless of whether you’re actively in consideration of making a transition, as the industry continues to evolve, you should be looking at the landscape every five years or so as well.

What does the landscape look like? How has technology changed? How has investment solutions changed? What might it look like in this other affiliation model?

Again, that’s something I help advisors with all day long is understanding that. I’m happy to have that conversation with you 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.

And at the top of every page is a Contact link. Click on that and 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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