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Also available as podcast (Episode #131)
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What Is The Benefit Of Controlling Your Local Expenses As An RIA?
TL;DR – Owning your own RIA, or joining an RIA as a 1099 enables you to control your local expenses. This control is beneficial in many ways including the ability to pay only for what you actually use in your practice, you get to decide how extravagant or lean your operation is, you have the flexibility to run your P/L as you desire, you have the ability to choose the composition of your team, you gain the economic benefits of managing your own office footprint, etc.
Host:
Brad Wales
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Full Transcript:
What is the benefit of controlling your local expenses as an RIA? That is today’s question on the Transition To RIA question and answer series. It is episode #131.
Hi, I’m Brad Wales with Transition To RIA, where I help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the model.
Again, TransitionToRIA.com.
On today’s episode we’re going to talk about what are the benefits of controlling your so-called local expenses as an RIA. I will define what that is and then go into what some of those benefits are.
But to be certain, this topic and the idea of controlling your local expenses pretty much applies to any sort of independent platform. So whether that’s starting your own RIA or joining an RIA that’s a 1099 model, or even an independent broker-dealer platform where again, you’re 1099 or independent contractor. This applies in all those independent scenarios.
But obviously as this is the Transition To RIA episodes, we will be talking about it in that RIA context.
To define what we’re talking about when we say local expenses, first let’s think about the traditional W2 model. Whether that’s a wirehouse firm or a regional broker-dealer firm, those types of firms, that model. I’ve done several episodes talking about payouts and economics and differences between a wirehouse model and the RIA model.
But the traditional W2 model generally has a payout, depending on your size, somewhere in the 30, 40, 50, up to maybe 50% range or so.
And as I always say, I’ve pointed out in other episodes, be careful because what they tell you is the payout, there’s usually all kinds of things they back out of that or other fees or deferred comps. So that’s generally not your true payout.
But for this episode, we’ll assume for simplicity sake you’re getting 40%. You might be higher or lower than that, depends on your circumstances.
And with a payout of 40%, that means your firm is retaining 60%. I always encourage you to look at the inverse of your payout and say… how much is that in dollar terms per year? And then what value and services is my firm providing me for what I’m paying them that 60% for?
A lot of advisors think of it as I get to receive 40%. I say, no, you’re the one generating the fees and commissions with your clients. Think of it as you essentially getting 100% of that, you then turn around and pay your firm the inverse of your payouts. In this example, that’s 60% and in return they are providing you with things.
Now in their defense, in the W2 model, they do provide you with a lot of things. They typically provide you with an office. They pay for staff, they pay for technology, they might pay for other resources that they provide for you to use as part of their value proposition.
But near term and long term, are you getting enough value from what you’re paying them? Is it good economics for you?
One of the benefits (of the W2 model) and for many advisors is something that’s very appealing to them, and that’s why they will forever stay in a W2 model, is that the firm handles all those things for you. For better or worse they provide you with an office. They often choose who your sales assistant’s going to be or whether you must share a sales assistant. Those sorts of things.
They do pay for all that, they do handle all those things. There is some benefit for advisors who say… “I solely want to be a practitioner, I solely want to be an advisor. I don’t essentially want to be an entrepreneur. I don’t want to have to be a business owner and decide some of these things. I just want to be able show up and leave at the end of the day and be an advisor and I love doing that.”
That’s fine. There are a lot of advisors where that is the career path they’re on now. That’s the career path they will ride out for the balance of their career. And that’s fine, but that does come with trade-offs.
Because the W2 firm is doing all this for you, using the 40% payout example, they are retaining 60%. It’s a bundled bill you get for their services. You don’t get a bill that says… here’s what we’re providing you with compliance support and here’s how much we’re charging you. We’re providing you with an office and here’s how much we’re charging. Or technology.
You don’t get an itemized bill to be able to see… what am I getting and what am I paying for it?
But again, to the degree you don’t want to deal with any of that stuff, they are doing it all for you, pros and cons to that approach.
In the independent space, one of the benefits is being able to control some of that yourself. Most independent models, whether you’re own RIA or you’re joining an RIA in the 1099 status, say (with the latter)… “We as the firm are going to provide you with certain things. (That’s their value proposition.) We’re going to provide you with perhaps technology, we’re going to provide you with compliance, etc. But you will be responsible for your so-called local expenses, the things that are local to you.”
That’s things like an office, your team members, paying the utility bills. It comes with more responsibility. But in turn, there are a lot of benefits to being able to control your local expenses, as opposed to relying on someone else to do it.
If you have your own RIA, you certainly are controlling your local expenses, you are running a business. Or if you’re 1099 on some sort of platform, while they do some stuff for you, they also typically push down those local expenses to you.
So, we’re going to go over some of the benefits of why that can be to your advantage to control your local expenses. Albeit, like I said, this is not for everyone. No matter what I say here, it’s still not going to resonate for all. Some people say… “I just want a W2 model. I want them to do it all for me. I get it. I’ll have less economics, less flexibility.”
That’s fine and there’s nothing wrong with that if that’s you. But to the degree you say… “I do want better economics, better flexibility. I do want to be an entrepreneur. I do want to be a business owner.”, there can be a lot of benefits to it as well.
In no particular order, and this is not an exhaustive list, but these are benefits of controlling your local expenses.
First, you only pay for what you use.
When you get the bundled value prop from your W2 firm, again, to use our example, you’re paying 60%, it’s all bundled together. You get what you get. There is no bespoke a la carte pricing that you get to choose and say… “I don’t use the big fancy conference room that you guys have built here in the branch complex, so I’d rather not pay for that.” No, it’s all bundled in. You don’t get that choice.
Depending on the technology that your firm does or does not provide for you, you don’t get to decide what you do or don’t get or what you do or don’t pay for.
When you have your own local expenses, you only pay for what you use.
We’ll get into things like real estate here in a second, but to the degree you don’t need a big fancy office or a big fancy conference room or multiple offices for your team, well, when you control your local expenses, you get to decide exactly what you are going to have and only pay for what you are going to have.
So the first big benefit is you only pay for what you’re going to use.
Because you choose what those variables are, you control your P&L, your profit and loss statement. If you want a fancy office setup, for example, well that’s going to cost you more, which you have control over. Or maybe you want a lean office setup. Guess what, that’s going to result in a higher bottom line to your firm.
Same thing with your staff. Do you want a large team? As maybe there are reasons that make sense. Or do you want perhaps a smaller team and maybe you outsource to third party vendors some of the tasks that otherwise need to be done?
Again, you have control over that. You decide how extravagant or lean you want that to be and that will drive your bottom line. But you have complete control over what that looks like.
Related, not only pay for only what you need, whether it’s fancy or lean, but you also get the flexibility to decide what that is.
A simple example, and this may or may not resonate with you, but I’ve encountered some advisors that, particularly in the last couple years with Zoom and how a lot of clients now want to meet remotely, or maybe a lot of your clients aren’t even local to you any longer, or maybe they never were, there are advisors that say… “I want some sort of conference room set up, but I want it to also be a so-called Zoom room.”
These are conference rooms that have a permanent set up with a good screen, a camera, good sound system. So when you do remote consultations with clients, you have a good set up that’s turnkey.
If you’re in the W2 space, that’s not up to you. Maybe they’ve done that, maybe they’ve implemented that in your branch and maybe can use it (albeit likely sharing it with other people.) But maybe they’re saying…. “We don’t think that’s a good use of the space we have available; or we don’t want to spend money on that.”
When you control your local expenses, you have the flexibility to decide whether to do that or not.
Another example I’ve seen with some new RIAs is they decide they want to have a podcast, and maybe make videos as well.
And they say… “We’re going to set up a podcast room in the office, and this is where we’re going to record the episodes. And we’ll have a video set up too.”
Again, if you’re W2, you might ask for something like this, you might raise your hand and vote for that. But there’s no telling that that’s actually going to be available to you.
When you have the flexibility, you can do whatever you want because you are the one paying for it. You can do what’s best for your practice, what your vision of your practice is going forward is.
Another example regarding flexibility is your team.
Because you control your local expenses, your team members work for your entity, for sure with your own RIA, and if you’re in a 1099 model while joining an RIA. You decide who your team is going to be and you are paying them.
There are benefits to having that flexibility.
Oftentimes in a W2 model, you must be at a certain production threshold to maybe get a standalone sales assistant or maybe to get a second sales assistant if that’s case. Or maybe you must share someone and you don’t really have a say in what you get from a resource perspective. The firm decides for you and decides that unless you’re at a certain level, you don’t get that extra position.
When you control your local expenses, you get to decide what resources you have.
As I mentioned earlier, you might choose to outsource. There are some great third party solution vendors that you can outsource certain tasks to. But as you might still want certain things done at the local level, you have your own team built around doing those things.
For example, maybe you use a virtual paraplanner to put together the financial plans that you present to your clients. Maybe you don’t need to do that at the local level.
Or maybe you do want to do that at the local level. Maybe that’s important to you to do at the local level, so you perhaps will have a paraplanner on your team.
Again, you get to decide exactly what roles, what team members you want and which ones you don’t want. The decision is entirely up to you regarding how you build your team.
As you grow and you need perhaps more support resources for your growing practice, you get to decide what that looks like.
And related, not only do you get to decide what those positions are, you decide who is going to fill them. You get to hire people, and if needed, fire people. It is up to you who these folks are going to be.
I’ve seen in W2 wirehouse scenarios where the sales assistants don’t even report to the advisors they support. There’s an informal arrangement, but they technically report to someone else and then technically that other person has essentially say over who is going to be in that role or if it’s time to move them on.
As the advisor in that situation, that W2 world, you might ask that a change be made or you might suggest that a certain person be hired or fired. But it’s not entirely up to you.
When you control your local expenses and you’re building out your local team, you decide who to hire, and who to fire, who to promote, or however you want to do it. It’s entirely up to you.
And then the last thing regarding your team, and this is not an exhaustive list, is you also get to set their compensation.
Because it’s your local expenses, your P&L, you decide what to pay these folks. That can be important from a flexibility standpoint because if there is a talented individual out there that you want on your team, and perhaps there’s a certain price point where that’s what it’s going to take for that person to join your team. If that works for your P&L, as you control your local expenses, you just do it.
If you are working for a W2 firm, they might say… “Nope, we don’t pay sales assistants above X dollars no matter what the circumstances are.” And next thing you know, you lose that talented person. They go get a job somewhere else because you couldn’t attract them, or you must subsidize it out of your pocket, even though you’re already paying the 60% to start with.
When you control your local expenses, not only do you pick the people you want on your team, you decide what to pay them. For some, that might be paying up to get talented people. And for other roles, you might not need to be paying an extravagant salary. Perhaps you have a good team member that’s content in that role and this is what the going rate is for that. You have control over that.
The final benefit I’ll talk about here, and again, this is not an exhaustive list, but it has a lot of parallels of what I just talked about, another big benefit of controlling your local expenses is your ability to control your real estate footprint, your office situation.
I’ve done episodes on the benefits of being able to control your own real estate as your own RIA or in the 1099 type model.
First, we’re going to use that 40% payout example I keep referring to, where you’re paying 60% back to the house and they’re providing you an office.
As an interesting aside, and I’ll use an extreme example, but the payout grid is the same for an advisor in lower Manhattan as it is for an advisor in the middle of Iowa.
We all know the real estate cost in lower Manhattan is significantly more than it is in the middle of Iowa. If you are the Iowa advisor paying 60% to the house, you are effectively subsidizing the Manhattan advisor that’s paying the same 60% to the house. Albeit they have much higher expense real estate that’s being provided for them.
Now, if you are the Manhattan advisor that maybe is working out to your advantage. Essentially someone else is subsidizing you. So it maybe a pro, maybe a con.
But if you are that Iowa advisor and you know your local real estate footprint is much less expensive than, again, extreme example, lower Manhattan, when you control your local expenses, you can realize that savings.
When it’s a W2 bundled payout approach, you have no control over that whatsoever.
Another big benefit with real estate, whether you own (which I’ll get to in a second), or you lease an office, is that office expense is a relatively fixed cost.
Now it’s not entirely. Let’s take if you lease an office. Typically leases have small annual increases, maybe 3% increase in rent. As it goes up, your costs go up slightly. I get it, it’s not entirely fixed.
But the idea being if you have an office footprint and you grow your practice over the years, the cost you are paying for real estate does not increase in lockstep with the growth of your practice.
Compare that to when you get that 40% payout, so you’re paying 60% to the house. As you grow your practice, yes, your payout might go up slightly and the inverse might go down slightly. But for example sake, let’s say you hit the maximum payout rate at your firm. You’re paying the inverse of that and they’re paying for your office as part of that.
Every incremental dollar in additional revenue you generate as you grow your practice, you’re still paying the inverse back to the house, part of which is paying real estate. The more you generate in fees and commissions and revenue for your practice, the more you’re effectively paying for the exact same real estate that you have.
Let’s say you double the size of your practice – this is an extreme example – and you’re already at the highest payout, and you double the size of your practice. They are not going to give you double the size office and double the size conference room (nor might you even need/desire it if they offered.)
Yet, with the W2 grid arrangement, the more revenue you generate the more you pay for your office.
When you’re independent, it’s instead a relatively fixed cost.
As you grow your practice, your office expense does not automatically grow incrementally along with it. Now, if you grow your practice large enough and at some point you need to expand the team, perhaps you might need more space.
But that cost increase is typically not in lockstep with your revenue. There are tremendous economies of scale by being able to have that fixed office cost yourself.
Related, and I did a separate episode on this so check it out as well, one of the big benefits of being independent is to be able to potentially acquire the office that you use.
The idea being that if you are going to be an advisor for the next 10, 15, 20+ years perhaps, and you are going to need or want an office (by the way, some RIAs are now partially if not entirely virtual), and you are going to be paying for it for the next 10, 15, 20 years whether it’s built into your payout, or you’re paying it directly, by buying a building instead, you can be building additional wealth for yourself.
Because you’re paying for the office expense anyways, you might as well be buying an asset at the same time.
I’ve seen advisors that have done this. A while back I was talking to an advisor and he was at the end of his career and was in the process of selling his practice, and he had told me how he had long ago bought the building he was in as well. He had spent all these years paying off a note on it.
And now at the end of his career, the building was worth almost as much as his practice itself was worth. Not only was he going to have the liquidity event of selling his business that he’s built up over the decades, he also now has this real estate asset alongside it that was worth about just as much. He’s basically doubling what he’s going to get out of his business that he’s built all these years.
You simply cannot do that in the W2 world. For better or worse, they’re providing it for you. You don’t have the optionality to own it.
When you control your local expenses, that is one of the big benefits to the degree that works for you, to the degree that’s possible. In some city environments, it’s easier said than done. But there are many advisors that have done it. The economic rewards can be tremendous.
I’ll wrap up by acknowledging I never try to view everything through rose-colored glasses. I’ve talked a lot about the benefits of controlling your local expenses. The extra flexibility, the extra economics. But it comes with the additional responsibility that goes with it.
Owning your own office, guess what, you’re the landlord. If something goes wrong with it, that’s yours to figure out. To be fair, if you’re in the W2 model and they provide it for you, you don’t have to figure out why (for example) some electrical issue arose in the office. Someone else handles that for you.
So, out of fairness, there is more responsibility that comes with all these benefits. But for folks that are playing the long game and are willing to figure out their local expenses, figure out their team and how to pay them, figure out their real estate, etc., the long-term benefits can be tremendous. Albeit there are additional responsibilities that come with it.
But for most advisors, the benefits far outweigh those additional responsibilities. And if that’s you, it’s certainly worth considering exploring.
With that, like I said at the top, my name is Brad Wales with Transition To RIA. This is the type of thing I help advisors with all day long is to help them understand, if you were to start an RIA, or join a 1099 RIA, what are all the variables involved? How does managing your local expenses occur? What are your responsibilities? What are the benefits? Why might you want to do that? And how does it all work?
I’m happy to have that conversation with you as well.
First things first though, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the model.
And at the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, whether you want to talk about today’s topic or anything else RIA related. I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
And with that, I hope you found value on today’s episode, and I’ll see you on the next one.
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