Q91 – What Is The Payout If I Join An RIA?

Also available as podcast (Episode #91)

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What Is The Payout If I Join An RIA?

Transitioning your practice to an existing RIA platform is a path chosen by many advisors. An important part of your due diligence of a firm is their payout. You will want to understand both how the payout is logistically structured, as well as what the bottom-line economics are and how it compares to alternatives.

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Full Transcript:

What is the payout if I join an RIA? That is today’s question on the Transition To RIA question and answer series. It is episode #91.

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

If you’re not already there, head to TransitionToRIA.com 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 RIA model.

Again, TransitionToRIA.com.

On today’s episode, we’re going to talk about if you were to join in RIA with your practice, what would the payout be?

There are several variables we’ll talk through regarding this. But to start with, and for those that have listened or watched a lot of my episodes, you’ll know I often talk about there’s three main ways you can transition your practice into the RIA model.

On one end of the spectrum is to start your own RIA and build out the necessary solution providers around it. On the other end of the spectrum is to join an existing RIA, which is what we’re going to be talking about today. And then there’s a third flavor that’s in the middle of those two along the spectrum.

As I often say, there are pros and cons to all three paths. It’s not to say that one path is better than another, and advisors go down all three of the paths.

If you were to join an RIA, today’s topic is, what kind of payout could you expect?

If you haven’t seen them, I’ve done some other episodes on joining an RIA. One is about whether you should consider joining an RIA in general (as your chosen path.)

I also did an episode on how to evaluate RIAs and whether they’d be a good fit for you.

I encourage you to check out those two episodes as well if you’re inclined.

But if you’ve made the determination to join an existing RIA, what kind of payout can you expect from the different solution providers in the marketplace?  Again, that’s what we’re going to talk about here.

We’re going to talk about how payouts are typically structured, and then we’ll get into some actual numbers of how the economics look.

There are all different kinds of RIAs you could potentially join. I talk about this in quite a few episodes. In theory, there’s over 30,000 RIAs out there. Now, a huge amount of them have no interest in adding advisors. A fair number of them would like to add advisors but arguably don’t have good value propositions. And then there are some very good solutions, with strong value propositions, that are looking to add advisors.

Even amongst the good ones, there are multiple flavors to choose from. This is a good thing for you, as you can ideally find a solution that is a very good fit for your specific practice. Whereas that same firm might not be a fit for some other advisor.

So, the good news is there are a lot of options to choose from. It’s more a matter of knowing which are the good ones, and which might best fit your specific situation.

But as an example on differing structures, some RIAs are structured as a W2 arrangement for you as the advisor, and some are structured as 1099.

Whether they are W2 or 1099 has a big impact on the economics and the payout involved. If W2, the payout is typically going to be a lot lower because hopefully in return for that W2 status, they’re in turn providing you with a lot more. That’s typically maybe an office, staff, benefits, etc.

Whereas 1099 – which is the more typical approach used – the payout is often much higher.  However, you in turn are responsible for managing, as they say, your local expenses. Things like procuring your own office (if you want one), your own staff, maybe local IT support, etc.

There is a big gap in economics between W2 and 1099. It’s something to be aware of.

For W2 offerings, it’s hard for me to give any sort of range of payouts, as the needle can move drastically depending on what value they provide you in return (office, staff, etc.)

To give you a general idea though, considering they are often extracting advisors out of the wirehouse models, the traditional W2 broker-dealer world, the numbers won’t be something drastic like twice the payout you get over there because they still have costs they have to cover for you, but they are typically better than what you could get in the wirehouse or typical W2 broker-dealer model.

Afterall, they’re having to provide a better value proposition for you, better economics to attract you in the first place to be looking at their offering.

So, just know that there’s a big difference when it comes to “payouts” or the economics if the value prop of an RIA you’re looking at is W2, versus 1099.

I’m going to spend most of the time here talking 1099 because that’s what there are more solutions using. That’s not to say there’s not some great W2 approaches, of which some might be a great fit for you.

With respect to 1099, there are essentially two components to it I want to discuss.

First, how the payout numbers are presented to you. There is not an across-the-board uniformity in how this is done.

The approach some firms use is to present their economics as a “payout,” like what you’ve perhaps had your entire career up to this point. Whether you’re in a W2 broker-dealer, or you’re at an independent broker-dealer, you get a payout. You receive a certain percent of the fees and commissions that you bring in as your payout. In a W2 model might be 40%, or an independent broker-dealer might be 80% to 90%, or something along those lines.

There are 1099 RIAs that also express their economics as a payout. One reason some RIAs do this is because it’s perhaps easier for an advisor to compare to what they get currently.

Other firms present their economics essentially as the inverse and do it as basis points. They might say, here’s everything we provide for you, and in return for that, we charge you X basis points.

Wherever you are now, let’s say you are at a W2 wirehouse and your payout is 40%, well, the inverse of that is 60%. So for the value and services your firm is providing you, you are effectively paying them 60%.

Advisors often think of their payout as what they receive. I always suggest they instead consider that they receive 100% of the client fees and revenues. Their firm is then providing them with certain services and value in return. There are hard costs for their firm to provide those services. The firm needs to make a profit as well. So they charge you for what they provide you.  What you’re paying is the inverse of your payout.

Now, whether your firm is providing you with a good value proposition and good economics is debatable, but you are paying for it.

With the RIA solutions expressing their economics in basis points, they’re just doing that math for you.  They are charging you the inverse.

It’s, here’s everything we provide you. You keep 100% of the fees that you bring in, but you pay us X basis points for this package of services that we provide for you.

Now, if you happen to charge all your clients exactly 1% – I know that’s hypothetical – that’s 100 basis points. An 80% payout, is mathematically the same things as a 20bps cost. It’s just the inverse.

As I work through some example economics here, to keep the comparisons easy, we’re going to hypothetically assume you charge every client exactly 1%. An 80% payout is the same thing as a firm retaining 20%, which is the same thing as a firm retaining 20 basis points.

If you’re considering more than just one firm, you want to make sure you’re making an apples-to-apples comparison.

Some firms use a payout, some firms use a retention figure (typically basis points), and some firm use a combination of both.  It might be, “the payout is X, but you also pay a couple basis points of Y.” There are different reasons they might structure it that way. But some use this combination approach.

The final thing I want to note before I give specifics is, be careful that there’s not also additional fees thrown in as well. Thankfully in the RIA world, this is not nearly as prevalent as it is in the broker-dealer world.

Let me give you an example I often see in the broker-dealer model. When talking to advisors in independent broker/dealer models, I’ll work to understand their current economics so I can explain how it compares to the economics in the RIA model.

When I ask what their payout is, they might come back to me with a seemingly high figure, perhaps 85%, 90%, 92%. And they note they already have a high payout.

However, I then ask if there are other fees involved as well, and they say, “Well, no, that’s my payout. I get a high payout.” And it does seem to be this generously high number, but then almost every single time after I ask the next question, it turns out there’s more to it.

I next ask, “Are there any other fees that you have to pay?” There typically is. It might be E&O fees, tech fees, etc. That can add up and you need to factor it in.

But the bigger item, what really moves the needle, is independent broker dealers will also often charge some sort of “platform fee” or “advisory fee” on fee-based accounts. A typical platform fee might be 20, 25 basis points.

Let’s assume it is 25 basis points, and you are charging your clients 1% for your services. So for the client, it’s your 100bps, plus the additional 25bps platform fee.

When I bring this up, advisors often respond by saying, “Yeah, but the client pays the platform fee.” And yes, the client is paying it. But the client doesn’t care who gets what behind the scenes. They just consider, “I’m coming to this advisor, who’s at this firm. What are they going to provide for me? And what am I going to pay for it?”

In the example I just gave, if you are charging 1% and your firm is charging a 25 basis point platform fee, the client is paying 1.25%. However, your payout is only on the 1% part of it. If you have a “payout” of 90%, you’re getting 90% of the 100 basis points “advisor fee.” You’re not getting 90% of the 125 basis points that the client is paying in total.

Again, the client doesn’t care who gets what behind the scenes. They just know they’re paying 125 basis points for the services they’re receiving.

I often equate this to resort fees at a hotel. If you look at room rates on hotels.com or wherever, you might see a good room rate. Well, it turns out after you get three clicks into the process, oh, there’s also a mandatory resort fee of $50 a day. It’s mandatory, you don’t have an option.

The room rate is not really what they say it is because if you also must pay a mandatory resort fee, you must factor that into the total cost.

It’s the same thing with payout rates. That 90% is not really a 90% payout if the client is also having to pay 25 basis points of which you, the advisor, receive none of.

If you were to move into the RIA model and that client is inclined to pay 125 basis points currently for everything you’re providing them, there’s no reason you can’t continue to charge them 125 basis points. However, in the RIA model, you can get a payout based on the entire 125 basis points, not just the 100.

The main takeaway is that when you compare your current payout to what the economics are in the RIA model, you must consider the full economics of your current arrangement. Many advisors often want to ignore the platform fee their clients are paying (at their current firm.)

Now, let’s get into some specific numbers.

The good 1099 offerings in the marketplace typically come with a cost that ranges from 10 to 30 basis points. Again, you could extrapolate that back to a payout, just consider the inverse.

Now, you might think, why should you ever pay 30 if there are offerings that only cost 10? Well, you get what you pay for. Not to mention, the number alone is meaningless. What matters is the value you receive for the price you pay for it.

It’s no different than a prospective client walking into your office, and before they understand the value you are going to provide for them, they ask, “What is your fee?” And you say, “Well, my fee’s 125 basis points, or my fee is 100 basis points,” whatever your fee is. And that’s all they have to go by. That number is meaningless.

There are some advisors that arguably provide minimal service to their clients for 100 basis points, and there are other advisors that provide tremendous value for 100 basis points. It’s a matter of what is the fee, and what value do I receive in return?

In the RIA model, there are RIAs will different value propositions to choose from. Some focus on providing just the core pieces of what’s needed to run an advisory practice, with a competitive price to match. If you want additional services on top, you can seek those out in the marketplace, and pay for them separately.

On the other end of the spectrum are firms that not only provide the core pieces but provide extensive in-house resources as well. Perhaps tax planning expertise, estate planning expertise, perhaps asset management is included in the 30 basis points.

You want to look at what is the fee, and what value do I get in return? Without jumping to the conclusion that less (price) is always better.

I’ll give an example. A while back an advisor reached out to me. He was at an existing RIA at the time, and he was frustrated because he felt the service and solutions he was getting from his firm were poor.

I asked him what they were providing for him, and to his credit, it wasn’t much. But then I asked how much he was paying for it. He answered 7 basis points.

I said, “Ok, let’s think about this. For a firm to bring you on and provide you some services, there are hard costs they have associated with that. They’re providing you with compliance oversight, and they have a cost to be able to provide that. They are providing you with some technology, which again has a cost for them. You’re rolling up under their E&O policy, there’s costs associated with that too.”

They might not be providing tax planning services, estate planning services, but they are providing some services. Those services have hard costs.

Next, any time an advisor joins a firm there is always some risk associated with that. That advisor might have a client that will one day go rogue and create all kinds of problems and want to make lawsuits. There are risks and costs potentially associated with that.

The advisor themselves might go rogue one day and cause headaches for the RIA. That’s a risk an RIA needs to be compensated for.

And then, of course, these are for-profit businesses. They need to generate enough profit to make this worthwhile.

So, as I explained to this advisor, out of seven basis points, they can’t possibly give you much more than they are. I don’t even know why this firm was offering what they were. They were maybe making one or two basis points on the advisor, which I would argue is not even remotely worth it for the risk, responsibilities, and everything they had to provide for the advisor.

Put yourself in their shoes. If it was your RIA and you were going to bring an advisor on, after covering all your costs, you wouldn’t do it for a one or two basis point profit. It wouldn’t be worth it to you for the responsibilities and risks, and everything you need to deliver. There needs to be enough margin for it to make it worth your while.

Not to mention, firms need to generate enough revenue to be able to reinvest back into their businesses, to roll out new services, new technology. There needs to be capacity to do that.

So, be careful about the cheapest option available. There’s usually a reason for that. It typically won’t work out in the long run.

The advisor I mentioned, he ended up looking at solutions that were about twice as expensive as what he was currently paying. And even then, he is still on the lower end of the price spectrum. But he was realizing he was getting what he was paying for. He would be better off paying twice as much, but getting more in return.

To wrap up, I want to finish with two quicks tips and reminders.

First, be careful about the extra fees. Are there platform fees? Are there additional bps if you use SMA managers?

Even though the client might be paying it, acknowledge those fees exist. And then determine how those fees would compare if you were in the RIA model. What would it mean for the client, what would it mean for you? Make sure you’re doing an apples-to-apples comparison.

And second, make sure to properly consider what you’re paying.

Let’s say you find a great solution that charges 20bps.  Don’t think of it as having to “pay” them 20bps. Reason being, if instead of joining a firm, you went out and started your own RIA, you’d have costs as well. You will have technology costs, compliance costs, E&O costs, etc.

If you’re considering a firm that “charges” 20 basis points, consider what it would cost you to try and build out that same set of services yourself. Which in some cases, because of a larger firm’s scale advantages, your total costs doing it yourself could exceed the 20bps.

But for example sake, let’s assume you can replicate the same set of solutions for 15 basis points. Those are the hard costs. However, you also must consider the intangibles of your time to manage everything, like compliance. The intangible costs (your time, risks, etc.) are harder to put pencil to paper on.

We can’t ignore those intangible costs, but for simplicity, let’s assume your all-in tangible and intangible costs of building and managing everything yourself comes to 15 basis points.

So, when you’re considering a firm that charges 20 basis points, you’re not really “paying” them 20 basis points. You’re only paying them the difference between what they charge, and what it would cost you to do it yourself.  In this example, the difference is 5 basis points (20 – 15 = 5.)

For five basis points, would you rather not be responsible for the compliance and regulatory stuff? Would you rather not be responsible for managing the tech stack? Would you rather not be responsible for the E&O? All these sorts of things.

All of it must be done one way or the other. Either you do it yourself, or you pay someone else to do it for you. I’m not suggesting one approach is better than the other. But don’t think of it as “paying” the full 20bps to someone else.

I hope this has been helpful. This doesn’t cover anything and everything with evaluating an RIA to join. Again, I’ve done other episodes on those topics. The devil’s in the details on the economics though. I hope that this has given you a general idea of what’s in the marketplace, what you can generally expect, and how they are structured.

I typically suggest advisors consider more than just one firm with their due diligence. You want to be able to compare one firm’s offering, to another possible solution. Firms might present their economics differently though.  Perhaps a payout, perhaps basis points, etc. Make sure you’re doing an apples-to-apples comparison.

Like I said at the top, my name is Brad Wales with Transition To RIA. This is the sort of thing I help advisors with. Helping you understand if the RIA model is a fit for your practice, and if it is, how to evaluate the potential pathways and solution providers to consider. I’m happy to have that conversation with you as well.

If you head to TransitionToRIA.com you’ll find all the resources I make available. This entire series in video format, podcast format, I have articles, I have 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.

With that, I hope you found value in today’s episode, and I’ll see you on the next one.

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