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Also available as podcast (Episode #135)
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What Is The Best Custodian To Use With Your RIA?
TL;DR – It is often thought there are only the “Big 3” (formerly the “Big 4”) custodians to choose from. While you might end up using one of the Big 3, there are closer to a dozen custodians in the marketplace to potentially choose from. To decide which one is the “best” for your practice, you must consider several variables that differ amongst the custodial options: minimum AUM requirements, approach to technology, how the offering is priced, what their value proposition is, etc.
Host:
Brad Wales
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Full Transcript:
What is the best custodian to use with your RIA? That is today’s question on the Transition To RIA question and answer series. It is episode #135.
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 all the resources we make available from this entire series in video format, podcast format. There are articles, 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 is the “best” custodian to use with your RIA.
And for reasons I’m going to get into, it’s hard to necessarily give some blanket statement about which one is the best because as you’ll see, different custodians appeal to different advisors in different ways.
We’re going to go through what some of those variables and differences are out there in the marketplace and hopefully it helps you realize that choosing a custodian for your RIA, whether you’re starting your own RIA, or if you’re joining an existing RIA – which part of the value proposition of an RIA you could join is they already have (usually, multiple) custodians available to choose from.
And so the question is which custodian should you use? And this is a big decision, as I’ll expand upon later in this episode.
For starters, it’s often thought of as the custodians in the marketplace as the “big three.” Now this used to be thought of as the “big four”, and the four previously were Schwab, TD, Fidelity, and Pershing. Schwab acquired TD, so the big four is now thought of as the big three.
But even then, it comes down to how you define big? Is that based on assets on the platform? Or based on number of RIAs served? So it gets a little blurred as there are other custodians that would argue that they’re in the big three based on the number of RIAs they serve, versus assets.
Either way, the reality is when you look at the whole landscape, there are closer to about a dozen custodians in the marketplace providing custodial services for RIAs.
Now, that doesn’t mean you will necessarily be interested in all dozen, and maybe not even half of the dozen. But it’s important to know they’re out there. It’s important to know there are differences. There are lots of different options.
The first custodian you talk to might not be the best fit for you. Now it might be, but you want to at least understand what’s out there.
To help with that, I want to go through some of the variables involved that differentiate the custodial options.
AUM minimums
First, most custodians, not all, but most custodians have some amount of AUM minimums required to use their platform.
Some custodians have no minimums. They’ll work with startups, to very large firms, and either way, don’t have an asset commitment from day one.
Whereas other custodians, due to their chosen business model, their value prop, do have minimums. For some custodians those minimums can run into the hundreds of millions of dollars in client assets, where they say… “if you want to use us as custodian we need to see that you already have (in this case) hundreds of millions of client assets.”
So just as a starting point, know some RIAs, depending on your size, might not even be available for you to consider.
Custodial pricing
Next, be aware there are different ways that custodians price their services.
Custodial pricing is an interesting variable in the RIA space. If you have your own RIA you’re going to be leaning on many solution providers including (just to name a few) a compliance firm, technology, E&O provider, etc. A custodian to hold your client assets is one of those solution providers.
However, unlike everything else on the list where the services provided are paid for directly by the RIA (ex: the RIA is paying the compliance consulting firm directly for their services), custodial services are generally paid indirectly by the client.
This is in part simply because that’s how it’s always been done. When custodians for RIAs ramped up decades ago, that’s generally how it started.
There are voices in the marketplace that suggest it should change. But generally, custodial services, historically at least, have been indirectly paid for by the client. The RIA does not write out a check to the custodian for their services each year.
I won’t go too deep into it, as I did an episode on how custodians generate revenue. But if you’re curious, what’s the catch, if the RIA is not paying for it, how is the client indirectly paying for it? An example is the custodian generates a spread on the cash sweeps that are in the account. Other examples include transaction revenue, payment for order flow, lending, etc.
There are several levers a custodian utilizes to generate revenue. But again, the revenue has historically not been paid directly by the RIA.
As a result, just as you are evaluating whether to do business with a particular custodian, they will also do due diligence on you. Do they want to do business with you in general, from your character and your background? But also, they will profile your practice and try to understand what kind of revenue it would generate from them.
Just because you have $400 million in assets doesn’t mean you’re going to generate the same amount of revenue for them as another practice that has $400 million in assets. It’s based on the various revenue levers. One practice could generate significantly more revenue for the custodian than another.
As a result, some custodians have moved more towards what is often referred to as an asset-based pricing model. Which is typically in basis points. You can call it a custody fee. You can call it a clearing fee, a platform fee, whatever you want. The indirect revenue sources might still exist, but there’s also, depending on the profile of your practice, a basis point custody fee that is applied.
Some RIAs line-item that fee out for the client and separately show them the advisor fee (perhaps 1%), and the separate custody fee (which when applicable, is usually a single digit bps.)
While other RIAs absorb the custody fee into their overall fee, essentially creating what is referred to as a wrap fee (and is disclosed as such in the RIA’s ADV.)
The idea being that some custodians utilize custody fees, while others do not.
Now don’t immediately default to saying… “I don’t want to even consider something that has a fee, when there are options that don’t have a fee.” Because you also need to understand, what do you get in return for that fee?
This would be like a prospective client saying to you… “why would I want to pay 100 basis points for your services when there are robo advisors that cost 25 basis points?”
Well, you’re providing two different levels of service, two different value props. That’s often the same with the custodians. What you get for the fee might differ from another solution where there’s no fee, but you’re not given as much value either.
You want to bake the entire cake and say… “I need certain resources to run my RIA. Are they provided by my custodian, and there’s a fee for it? Or am I going to source those resources on my own, which they’ll be separate costs for?”
At the end of the day, you still might go with the one that doesn’t have a custody fee because that still might be the better solution for you. But main point being just know that there are differences in how the custodians price their services.
Technology
The next variable to be mindful of is how technology typically works with custodians.
There are essentially two ends of the spectrum to this, with some merging to the middle. It’s not to say one of these approaches is better than the other. It’s ultimately what’s going to be most appealing to you and helpful for your practice.
On one end of the spectrum from a technology perspective are custodians that say… “We provide some core technology that’s part of any custodial operation, such as facilitating a trade in an account, doing money movement between accounts, etc. But for things like a CRM, financial planning or portfolio management, as opposed to us trying to build that ourselves, we instead spend our resources integrating with the best in class third-party tools. You go and choose, for the most part, whatever technology solution you want for your so-called tech stack. You build that and we will integrate with that.”
The other end of the spectrum is there are some custodians that say… “We believe that for many, if not most advisors, it’s better and cheaper and more efficient if more of the technology is built into the custodial offering itself. There’s less issues with data flowing back and forth. Less issues with integrations. We’ve taken a big chunk of what would typically be in a third party tech stack, and we’ve built it into our offering, and here’s how we price it.”
So, know that there are different approaches to technology by custodians.
Value propositions
Next, custodians have different value propositions.
It’s not to say – and I’ll give you some examples of them – that one of these value props is superior to another. All that matters is what resonates best for you and your clients.
Some custodians have the scale game. They can claim to be the largest, or one of the big three. Others, it’s name recognition where they have a long-established name, a respected name, a well-known name. Whereas others have less name recognition.
A thing to keep in mind is that arguably about 85% of what a custodian does is basically a commodity. It’s basically the same at every custodian.
One custodian’s ability to facilitate a trade of an equity is generally no better or worse than any other custodian’s ability to do it. Yes, there’s order flow and it’s not perfectly exact, but generally speaking, it’s the same.
One custodian doesn’t necessarily have a far better client statement than another one does.
All custodians are tasked with keeping client assets safe. That’s the number one purpose of a custodian. Now that’s not safe from market fluctuations, but safe with respect to safeguarding client assets. They all must have that. They’re all regulated the same.
And so 85-ish percent of what a custodian does is roughly the same. It’s that give or take 15% where their value prop comes in of what makes one custodian different than another.
Is it important for you that you work with the biggest player in the space? Is it important you work with one that has more name recognition perhaps with your clients than another one? Is it one that has arguably better technology than another one does?
It’s the value prop where you start to see the differentiators, and again, don’t get caught up on the 85% because it’s roughly going to be the same in that sense.
Services
Next on the list, and this parallels value prop, are the services that a custodian provides.
This depends on the kind of clients you have. Some custodians will be able to handle and service certain types of clients better than others.
Perhaps you have a lot of high net worth, or ultra high net worth clients and they need specialized lending services easily available via the custodian. Some custodians are far more equipped to service that than other custodians are.
You want to consider what services you can get from a custodian, whether it’s a need or a want.
And that comes back to don’t get blinded by (custodial) price alone because you need to understand what value prop they have, what services do they have? Some of which you might need for sure because of your client base.
So, you want to consider the service offering.
Hybrid
Then the final variable, and this is not an exhaustive list, is how – I’ve done episodes on this – you do not have to be 100% fee only to be in the RIA space.
The RIA itself only has advisory assets, and the custodian, in this context, only holds advisory assets. But many RIA practices also have legacy commission assets that they’ve had for a long time, and perhaps there’s also a need or desire to continue to be able to offer commission broker-dealer based solutions going forward.
There are many RIAs that have a hybrid structure. Which I lament often how be careful when someone uses the term hybrid, as it’s used by different folks in different ways.
In my context here, I’m indicating it is where there’s an RIA and there is also a need for some sort of broker-dealer solution as well. Some custodians are set up arguably better to accommodate that hybrid solution than others.
If that is going to be you, and you’ll have a need for a broker-dealer component, just be aware some custodians are better equipped to service that or be your partner for that than others.
So those are just a couple of the variables to help you think about how there are a lot more custodians than you might realize, and there are more differences between them than you might be realizing.
Final thoughts
I want to leave you with a few final thoughts as well.
First, choosing a custodian is going to be a big decision. If you transition to the RIA model, there are a lot of decisions you must work through. That’s a large part of what I help advisors and teams with is understanding what you need to solve for, what are the decisions you need to make, why you might choose one provider over another, etc.
All the decisions are important, but arguably one of, if not the biggest decision you make is which custodian you choose initially.
The primary reason is it’s highly unlikely that after you choose a custodian and you move assets to them, it’s highly unlikely that you will one day move those assets to another custodian.
You can do that if you desire. As an RIA, you can certainly add a custodian – I’ll mention that in a second – or you can replace your custodian if you want to move assets. But the reality is, if your clients are happy with you, and nothing else is changing with the RIA, typically RIAs do not want to go to their clients and ask them to move their assets from one custodian to another.
It’s doable. It’s just not desirable in most instances. It does happen on occasion, but for the most part, it doesn’t. I’ll just be blunt.
So, this is a big decision you need to make because if you follow that trend, you likely will not change custodians, at least with whatever assets you start with at that custodian, unless something drastically happens along the way with the custodian that essentially forces you to overcome the friction of making a change.
That is a big part of what I help advisors and teams with is understanding who are their custodial options, how are they different? You want to make this very big decision correctly on the front end, knowing the long-term ramifications that decision will have.
Related to that, it is likely that if you start an RIA, and you have some size, and you continue to grow, your practice is measured in hundreds of millions of assets if not larger, most RIAs when you reach that echelon typically will become multi-custodial at some point.
I’ve done an episode on being multi-custodial. There are different reasons you might do that. I won’t go into it here, but it’s likely that you will become multi-custodial at some point.
But it’s also likely that you will start with one. That’s typically always the best practice because you are going through a transition, you already have enough moving parts involved. You already have enough logistics to figure out and work through with your team, with your clients. You don’t want to add unnecessary complexion by using two custodians from the jump where you’ll have two different systems, maybe two different approaches to technology, two different ways to open accounts.
It is generally always advisable to start with one, but likely over time, if you continue to grow and become large, or again, if you already are large, it will just make sense at some point for you to become multi-custodial.
So just know that this is not just a one-time decision. You might be adding custodians at some point. But again, it’s not as likely that you would add a custodian and move existing assets.
Next, and I have this conversation often, if you are at a firm now that’s perhaps an independent broker-dealer that is not self-clearing, so they rely on a third-party clearing firm, the main players for the third-party clearing firms typically also have a custodial channel.
Which is you’re at such an independent broker-dealer, you might think… “I like this underlying firm holding my client assets, and when I start an RIA I just want to keep my assets here. This will be a simple little switch.”
Just to set expectations, it’s not a simple process like that. It might not even be available to you.
Very quickly, I certainly can go into this in more detail with you if this applies to you, but if you are at a broker-dealer now and that broker-dealer clears through such a firm, keep in mind, you as the individual are not the customer of that clearing firm. Your broker-dealer is the customer of the clearing firm. And your broker-dealer is many, many, many times bigger than you are individually.
The clearing firm wants (and needs) to protect that much larger relationship. So if you say… “Clearing firm, I want to leave my firm and go on your custodial channel.” The custodians are in the business of attracting, and equally important, retaining assets. They would like to do that. They don’t want to see you leave and take your assets elsewhere.
However, they do have a quagmire because they need to protect that much bigger relationship and they don’t want to give any impression that they’re going behind the back of that firm to help facilitate you leaving that firm.
That is something I can talk through with you if that applies to you. It’s a quagmire the custodians would prefer to not be in, but it’s just the reality of them having multiple different channels. And each of the firms handle it differently.
And just know, even if you can overcome that, it’s not just flipping a switch and the accounts are moved. There’s still paperwork involved.
The final thing I’ll leave you with… hopefully this has opened your eyes to how important this decision is, the number of custodians in the marketplace, the variables involved, some of the possible challenges or hurdles you must work through
But do not be intimidated by that. That is what I am here to help you with, to help you understand the landscape. Let’s look at your practice, let’s look at your plan for your practice going forward, the kind of clients you serve, how you would like to approach technology, how you invest assets, the economics involved.
A big part of what I do is help you choose which custodian would be best for your RIA. And hopefully by everything I’ve said here, you can understand why there is no singular best custodian out there that I could just say is best for all RIAs.
I’m here to help you with this. Do not be intimidated by all the decision variables, but it does behoove you to do the education, to be aware of all this. And again, when I’m talking directly with you about your specific practice, I can help you figure out specifically which custodian would be a fit.
Like I said at the top, my name is Brad Wales with Transition To RIA. This is a very typical thing I help advisors and teams do is understand should you even be making the transition to the RIA model? And if it makes sense, there are multiple pathways you can go on. And then regardless of the pathways, there are all kinds of decisions that need to be made. The custodian, as I said, is one of the biggest decisions in that process. I have that conversation all day long, and I’m happy to have it with you as well.
First things first, head to the website TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. There are articles, there are whitepapers.
At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, whether you want to talk about today’s topic or anything else RIA related. I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
And with that, I hope you found value in today’s episode and I’ll see you on the next one.
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