Also available as podcast (Episode #94)
Why Go RIA When Wirehouses Offer Huge Upfront Checks?
You don’t have to look far to find a wirehouse firm discussing the large upfront bonus checks they offer advisors that join them. Not mentioned are the significant handcuffs that come along with such checks. The aggregate economics for an advisor over the length of the vest period are generally far inferior to other available options. Coupled further with significantly less flexibility with how you can run your practice, advisors come to realize the bonus checks are not as appealing as they at first seemed. It is worth understanding the trade-offs you are forced to accept in return for such a check.
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Why go RIA when wirehouses offer huge upfront checks? That is today’s question on the Transition To RIA question & answer series. It is episode #94.
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.
On today’s episode, we’re talking about if you’re an advisor considering options in the marketplace and you’re thinking, “Maybe I should go down this RIA path, I should learn more about it, maybe that’s the right fit for me. But there are wirehouse firms offering huge upfront checks, bonus checks if I join them. Why should I go RIA when wirehouses are throwing this money around?”
What prompted me to make this episode – and this is nothing new, I just happened to see a few of them recently – is you see a lot of firms leading with that message. Whether it is wirehouses trying to attract advisors and they’re touting all these big checks, or industry participants that help advisors try to find a wirehouse and that’s their lead-in line, “Are you aware of the big checks being offered?”
That is a lazy approach. That’s not helping advisors understand how different options compare, what different models look like, how the economics work, or anything like that. That’s just a lazy way to basically say, “Look at this big shiny object, and look how great this is.”
That must be considered, but it’s only one of the variables involved. Particularly when considering total economics, it’s just one variable. So, I think it’s a very lazy approach that a lot of industry participants use to try to get advisors’ interest or to peak a conversation.
It’s been going on for a long time, but I happened to see some examples recently that prompted me to make this episode to clarify some of the differences between what happens when you take that check and how that would compare if you had gone down the RIA path instead.
For starters, just a quick little clarification. There are multiple different ways to transition your practice into the RIA model. One of those paths is to join an existing RIA. There are some RIAs that offer upfront, often referred to as, transition assistance or TA if you join them.
So don’t have the impression that, “If I go down the RIA path, there’s no upfront money.” In some cases, there’s not. But the economics are such that that’s not a bad thing, which we’ll get into here in a little bit. But just know that there are some firms that do offer some amount of transition assistance.
But to be clear, even though it can still be a reasonably healthy number, it’s nowhere near these large shiny checks that the wirehouse firms like to wave around. But just know that it exists in some cases.
From there, I want to give five observations about the ramifications of taking the large upfront check and how that differs if you had not taken the check and transitioned to RIA instead.
First observation, the large check they’re offering is not a gift. That’s not free money. That’s not the wirehouse just being generous saying, “Let us give you this money.” A lot of folks see it that way, “They will give me this big upfront amount of money.”
I remember an advisor on a podcast – and unfortunately I can’t remember what podcast it was or what advisor it was, to give them credit – but I thought they articulated it best about large upfront checks.
They said, “No, no, no. It’s not the firm giving you a check, or a gift, or a bonus. Hey, advisor, that’s your money! That’s your money they are giving you. They are just giving you a big chunk of your money upfront, as opposed to over a series of years.”
It’s your money. They’re not giving you a gift. They’re not giving you their money, except for from a cash flow perspective. They’re essentially fronting you your own money in return for locking you into all kinds of restrictions, handcuffs, etc.
It’s not free money by any stretch of the imagination. It’s your own money and it comes with significant handcuffs, which we’ll get into here as well. But you should mentally reset how you think about it. It’s not charity. They’re not gifting you money freely out of their own pocket.
The next observation, when you’re looking at the economics of a possible transition you shouldn’t look at just one piece of the economics.
You need to look at the aggregate economics in total. Not just, what do I get essentially on day one, that proverbial upfront check? You need to look at what do I get over the lifetime of my career while I’m in that model? What does that math look like? Including on the tail end when it’s my succession point, and there’s a valuation put on the practice.
You should consider all three in aggregate. You can’t be blinded by the upfront piece alone.
It’s human nature to often be blinded by whatever this shiny object is here on the front end. An analogy relates to buying a car.
If you’re going to buy a new car, from a rational economic viewpoint, there are three things you should factor into your decision on the economics of acquiring that car.
First, what is the price of the car? What you must pay on day one. That is very meaningful, that catches your eye. How much does this car cost?
Let’s say you plan to keep the car for five years. You next should consider, what is the average cost of maintenance for this vehicle over the five years? There is data online where you can get that. Some cars are known to break down more than others. The repairs on some cars are more expensive than others. You need to factor in this cost of ownership while you own it.
And last, you should consider what is the resale value of the car going to be (at the end of the five years?) Some cars hold their resale value better than others. You need to know what that is.
If you’re buying a car, you should consider all three of these variables in aggregate. That’s the economics you should be considering. I know there’s other variables on why you might pick one car over another, but with respect to the economics, this is how you should view it.
But as humans, we don’t generally do this. I’m guilty as well. We far overweigh what the initial sales price is when that’s only one-third of the puzzle.
It’s the same thing with large upfront checks. You can’t get blinded by that day one economic event. Yes, it might feel good, you might get that dopamine hit to get that big check, and it goes in your pocket on day one. But in return, if you’ve just committed to maybe a 9, 10, 11, 12-year lockdown with that firm, day one will move on to day two very quickly. You should be looking at the entire piece of the puzzle. The aggregate math. Don’t be blinded by just what happens on day one.
Next, if you like that day one excitement and that dopamine hit and, wow, that big check, reality is, if you were so inclined to have that big event, you could manufacture the exact same thing in the RIA model, as you get in the wirehouse model.
Let’s use very simple math as an example. Let’s say you produce $1 million per year in fees and commissions. A wirehouse offers you an upfront check to join them. In return, your payout is going to be 40%.
Now it’s never that easy with respect to a payout. I’ve ranted about this a lot. There are kinds of limits to the payout. 40% is not what would reach your pocket. But for simplicity sake, we’re going to say it does. So, you’re taking home $400,000.
In the RIA model, at that same level, million-dollar producer, you might reasonably be able to take home 60% at the end of the day. The RIA path, however, doesn’t include an upfront check.
So, with one path (wirehouse), you get a big check. But from there on after, for perhaps 10 years or more, you get $400,000. The other path, with no upfront check, you get $600,000. That’s a difference of $200,000 per year.
If you were inclined to want a big check on day one, on the RIA path, you could in theory go and borrow the same amount of money as the wirehouse check. So that just as with the wirehouse path, that cash hits your account day one.
You put that in your account, you feel good about it. Wow, look at this big amount of cash I just got. And then over the balance of, say, a 10-year period (to mirror the wirehouse path), you use part of the additional $200,000 in earnings each year to pay the loan back.
You can effectively manufacture your own upfront check if you want. Now, you might say, “Why would I do that? I’m going to pay interest on the loan. That doesn’t make sense to put it in my pocket, just so I can see it there and then have to pay it back.”
But that’s what you’re doing in the wirehouse world. You’re getting the big check. Effectively, you’re paying that back under very onerous loan terms via a much lower payout, and with much tighter restrictions on your practice.
But just know, if that was important to you, you could, in theory, hypothetically manufacture your own upfront check.
Next on the list, is to remind you that the big upfront check of the wirehouse world is (ultimately, as it is forgiven over the length of the term) W-2 income, taxed at personal income tax rates.
Whereas in the RIA world – and let’s assume you don’t manufacture your own upfront check – you get to treat your higher income under the much more advantageous terms of a small business owner.
The tax benefits of being a small business owner are generally significantly better than they are as a W-2 employee. Now, we could argue, is that fair or not, as a society? The ability to expense things, the ability to depreciate things, the ability to contribute more to retirement accounts, etc. It absolutely is more advantageous in the independent space than it is in the W-2 space where you’re paying personal income tax rates.
So that upfront check, if you can instead be patient and just wait for it to come in over time (via higher income), the way you can treat that from a tax perspective is significantly better.
Now I realize if you get the big upfront wirehouse check, you’re not taxed on it all in year one. You’re taxed throughout the life of the vest period. But it’s still W-2 income tax rates that you are paying on it. That same money can be taxed differently as an RIA, as an independent business owner.
Finally, and this always blows my mind, if you take that giant upfront check from a wirehouse, you’re locking yourself in for perhaps 9, 10, 11, 12 years! I talked to an advisor the other day that the way his bonus had been structured, it would take 13 full years for it to fully vest and him not owe any money back if he were to leave.
Now, you might say, “I’m not locked in. I can always leave. I would just owe it back.” Technically, that’s true. I would tell you from my years of talking to advisors, though, it’s very hard to mentally do that. Once a couple years pass and you’re removed from the initial deposit into your account – maybe you’ve even already spent it, paid off your house perhaps – even if you’ve been good about saving it, it’s mentally hard to one day write a check to pay some of it back. Perhaps hundreds of thousands of dollars. It’s mentally hard to do that.
It blows my mind that people are willing to, for the sake of that upfront check, lock themselves into perhaps 10+ years with a firm, during which they have no control over changes that are going to occur.
There could be a change to the branch manager. There could be change to regional management, firm management. Who knows what decisions those folks will make that could impact the advisor’s practice?
And don’t forget changes to the payout, that generally occur every year. Those changes usually never benefit the advisor. So, you’re willing to take a check on day one and have no control over how your economics will play out over a decade or more. Historically, payout changes happen and those changes are not in your favor. You are willing to trust that that won’t go too sideways on you, that those changes won’t be too impactful over 10+ years. That is a big leap of faith!
If you take that big upfront money, it’s not free money. You are now tied in for a very long time where you have little to no control over changes that will impact your practice.
Now let’s shift to if you instead went the RIA route and played the long game.
So, those are kind of just some quick… That’s not an exhaustive list of some of the challenges of taking that upfront check.
Don’t be blinded by the day-one economics. If you take the upfront wirehouse check, you in turn get a lower payout. If you go the RIA route, there’s maybe no upfront check, but you get a higher payout.
The aggregate math of the higher income will eventually turn in the favor of the RIA advisor. It might take two, three, four, five years, before the aggregate math exceeds the math you’d achieve receiving the upfront check that comes with the lower payout.
However, if you are committing yourself to 10 years or more – as you do when you take that check – it doesn’t matter if it takes a few years before the crossover breakeven point occurs. What matters is the aggregate math over the entire 10-year duration.
The example I often give – which with increased interest rates of late is not as good of an example any longer – is with refinancing a mortgage.
If you were in a situation you could refinance your mortgage to a lower interest rate, you have to pay closing costs on the new loan. However, you’ll save money each month on your lower interest expense.
You can run the math on when the breakeven point occurs. You might have to pay however many thousands of dollars upfront, but each month you’re going to start saving maybe hundreds of dollars a month in interest.
You do the math, “As long as I’m in my house another (for example) two years,” – or whatever the breakeven point is – “I am better off indefinitely after that.”
It’s similar aggregate math for our advisor example. The wirehouse advisor will be better off for the first couple years, but the aggregate math eventually crosses over. If you’re willing to play the long game, which you should because you’re committing to playing the long game, you’re committing to 10+ years (if you take the check), you might as well consider the aggregate math and make your decision based on that instead.
Related, if you are committing to playing the long game – let’s say at least 10 years – that means you’re committed to at least 10 more years in the industry. Over that 10 years, you presumably want to continue to grow your firm.
If you’re going to lock yourself in for 10 years, would you rather lock yourself into a model that is very restrictive on how you can market and brand yourself, the services you can offer your clients, the tools you can use as an advisor to manage your practice?
In the RIA space, you have significant more flexibility with what services you offer your clients, how you run your practice, the technology you use, etc. If you’re committing to 10 more years, would you rather have much more flexibility or much less flexibility. Flexibility you really have no control over. Someone else dictates to you what you can or can’t do?
Next, and this comes back to the aggregate math, don’t overlook the enterprise value of your practice at the end of, for example, the 10-year commitment you’ve agreed to.
Let’s say you take the big check, and you plan to retire at the end of the 10 year period. You plan to take the firm’s, often called, sunset program at that point. You need to consider how they’ll value your practice for that. It’s the equivalent of the future resale value of the car.
The valuations of a practice in the RIA model are significantly better than what is offered in sunset programs at wirehouse firms. Part of that significance is how it is taxed.
In the wirehouse sunset program, the income paid to you for your practice is taxed at W-2 personal income tax rates. In the RIA space, you generally can structure your liquidity event so perhaps 85% of it is taxed at capital gains tax rates.
If you take the big check, factor in the valuation of your practice at the end of the 10 years. And just as important, its often overlooked, on an after-tax basis. You must factor that into your calculation.
When you start running this sort of math the big upfront check isn’t so appealing any more. It’s exciting on day one, but in aggregate, the math is not looking so good anymore. You must factor all that in.
The last point I would make is, when you take the big check, remember you are locking yourself into something for 10 or more years where, again, all kinds of changes could occur. You have little to no vote in all that.
In the RIA space, particularly if you have your own RIA, you still must adhere to regulators – as do all advisors – but you have much more flexibility to make changes with your practice over that period. You’re not locked in.
If you go down one path, let’s say you join an RIA, that’s the best next step for you. And then five, six, seven years into that, you decide at this point, I want to have my own RIA. Well, guess what? If you’ve chosen the right solutions to go with from day one, you’re able to do that, there’s no ramifications. You don’t have to worry about being sued or anything like that. You don’t even have to move your assets again. You have that flexibility.
You’re not locked into 10, 11, 12 years where you can’t do something unless you’re going to write a big check back, which, again, just doesn’t happy much in practice.
Don’t put yourself in that situation, to begin with. Have flexibility. If you’re going to commit to 10 years, you might as well have more flexibility with how you run your practice and what you can do with your practice.
I hope this has been helpful. You can tell I’m passionate about not getting blinded by big upfront checks. It’s frustrating when I see laziness in the marketplace. Whether it’s the firms writing the checks, and that’s their lead-in message, or it’s people in the industry that are trying to help you figure out your next path and that’s their lead-in line, because they don’t want to take the time to explain this to you, or they’re not familiar with how it works to begin with.
It’s easier for them to say, “Wow, have you seen how much this firm is paying! This is the most that’s ever been paid!” I think that’s a lazy approach. Don’t get blinded by it.
It never hurts to consider your options. Consider the wirehouse model if you want. But consider the RIA model as well. At the end of the day, if you take the time to fully peel the onion back and look at all the variables, the RIA model almost always wins when you put them side by side. I’ll quit my rant, but you can see I’m quite passionate about this topic.
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. If you’re at one wirehouse now, maybe you’re thinking should you go to another wirehouse, they’re offering big checks, consider how that would compare if you went RIA instead. That’s the kind of conversation I have all day long. I’m happy to have that conversation with you.
In the interim, if you want to learn more, head over to TransitionToRIA.com.
You’ll find this entire series in video format, podcast format. I have articles, I have whitepapers. The easiest thing to do though is 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.
With that, I hope you found value in today’s episode, and I’ll see you on the next one.
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