Pat Howley plans to cut the cord and become a fee-only advisor — only he's not rushing it. Howley left Wachovia two years ago, after 20 years at A.G. Edwards, to join the Moneta Group, an RIA in St. Louis, determined to drop his Series 7. But, with 60 percent of his business in commissions, he knew it couldn't happen right away. Since then, he's slowly moved to fees. Today, 90 percent of his book is fee-based; in another year, he figures he'll be able to hang up his Series 7 license for good. “You can't go cold turkey overnight,” says Howley, whose practice has $300 million in assets and about $1.4 million in revenues. “This is a long-term process.”
A lot of advisors are thinking about making the fee-only switch. About 35 percent of dually registered advisors who changed channels in 2010, for example, moved to an RIA, according to Cerulli Associates. It's a useful marketing differentiator, of course, one with which you can establish your credibility easily as a responsible fiduciary. Wealthy investors are increasingly insisting on the model, since they like the reduced conflict of interest. Mark La Spisa, for example, an RIA in South Barrington, Ill., whose firm Vermillion Financial Advisors has about $150 million in assets, decided to give up his Series 7 license in 2008 after a $5 million client left him for a fee-only advisor.
It also provides a way to cut down on regulatory hassles, since fee-only advisors are supervised by the SEC or state agencies, depending on the size of the firm, instead of “also having to labor under the FINRA lens,” says Dennis Gallant, president of Gallant Consulting, a consulting firm in Sherborn, Mass., though fee-only advisors can expect additional regulatory burdens under pending Dodd-Frank rules. In addition, making the switch is less of an ordeal than even a few years ago, thanks to everything from new software to a critical mass of firms trying to attract newly minted fee-only advisors.
Still, as Howley discovered, the process takes time, planning and patience. It includes communicating your plans to clients, deciding on the best business model, looking for new technology and compliance systems, and figuring out what to do with commission-based investments, not to mention preparing for how to handle a temporary loss in revenues. “The key is three words: planning, planning, planning,” says La Spisa, who spent a year getting ready before leaving his b/d.
Before you do anything, you need to take your clients' pulse to make sure they like the idea. That means meeting with them, preferably in person, to discuss your plans. In some cases, the results may reveal that making the switch isn't feasible. “If you risk losing most of your book, it's not a good idea,” says Tim Oden, senior managing director for business development for Schwab Advisor Services. “You don't want to find out after the fact that the plan doesn't appeal to your client base.” He points to one advisor who had about 50 percent of his book with retirees, most of them from one Fortune 50 company. For these clients, the costs of working with the advisor were low, since they tended not to buy a lot of stock and paid on a transaction basis. The result: When he polled them to find out how they'd feel about his switching to fees, the overwhelming response was negative. He decided not to make the move, but, instead, to have his partner, who was younger, develop relationships with clients' children and work towards switching to fees at a later date. “It would have been a terrible decision to make the move right away,” says Oden.
Once you decide that you want to give up your Series 7 license, you'll need to analyze your book of business and make some tough decisions about which clients to keep or shed. That's, in part, because working as a fee-only advisor requires dedicating considerably more time to serving clients — there are additional meetings, planning, discussions. As a result, it might not be cost-effective to continue working with some of your smaller accounts. “It takes the same amount of effort to serve a $50,000 client as one with $1 million,” says Chris Winn, president of AdvisorAssist in Humarock, Mass. “But to continue with both will end up hurting your growth.” In addition, according to Winn, you might just not be able to make a convincing case to smaller accounts. “Most likely, it won't be possible to justify the fee,” he says. In some cases, if you're joining an existing firm, you might have little choice in the matter. For example, because Moneta's minimum is $1 million, Howley had to eliminate smaller clients from his book.
That's not all bad. In fact, for many advisors, the process provides a handy opportunity to bite the bullet and get rid of unprofitable or simply difficult clients. La Spisa, for example, analyzed his book, looking at such non-financial questions as, he says, “What kind of follow-up did they require? Were they easy to work with? Did they keep appointments? Were they nice to the staff?” As a result, he decided not to switch over several accounts.
When you know which clients to keep, you'll need to segment them, if you haven't done so already, and figure out what it costs to provide service to each grouping. With that information, you can pinpoint the number of clients you can afford to serve profitably and how much time you'll need to spend per account. It's more complicated than you might think. For example, just because two clients are in the same segment doesn't mean they'll require the same amount of time; one might email you every other day, while the other might contact you once a quarter. In fact, advisors often underestimate just how many clients they need to serve or the size of assets per client they require to be profitable. “Often, they discover they have to work with more clients or larger clients than expected to generate the revenues needed to make the practice work,” says John Nersesian, managing director of Nuveen Investments in Chicago.
Client issues are only one piece of the planning puzzle, however. There also are operational matters. The reason: Your former b/d took care of many tasks, from compliance to supplying technology and errors and omissions insurance. But without that affiliation, you'll need to handle all that on your own.
Take compliance. As an RIA, you'll have to appoint a compliance officer and conduct annual audits, an SEC requirement. “You have more freedom, but at the same time, you have the responsibility of making sure you're following securities laws,” says Winn. Initial set-up can range from $10,000 to $30,000, according to Philip Palaveev, president of Fusion Advisor Network in Elmsford, N.Y. Plus, you'll need to set up a process for following policies and procedures, which should add to the cost, though the amount is difficult to quantify, according to Palaveev.
At the same time these days, it's possible to outsource a great many tasks, though it can be expensive. Using an outside compliance consulting firm, for example, costs from $5,000 to $10,000 a year, according to Palaveev. Or, you can cut some costs by using cloud applications. Jude Boudreaux, who started his own New Orleans-based practice in September 2010, after working for five years heading financial planning at a fee-based firm, uses a wide array of cloud-based applications, from FreshBooks for accounting to MailChimp for email marketing. He figures he cut his technology costs in half, as a result. “I pay on a monthly basis instead of spending money for a server and a lot of expensive software,” he says.
You can also avoid having to take on many of these responsibilities by joining an existing RIA or a roll-up, like HighTower and Focus Financial, that take a lot of the technology and compliance burdens off your shoulders. That's the primary reason Howley chose to join Moneta rather than start his own RIA from scratch. “It's certainly simpler to go fee-only if you don't have to worry about setting up an office or figuring out the technology,” says John Furey, president of Advisor Growth Strategies in Phoenix.
There's also a fair amount of paperwork required to switch clients' accounts. One way to cut down on the paper-pushing is to remain with your b/d, if it allows advisors to do fee-only work. When Fred Dent, whose Baton Rouge-based firm Dent Asset Management has about $150 million in assets, made the switch in 2009, he chose to use his former b/d Raymond James as his custodian. That was, in part, because while there was some paperwork involved, he didn't have to go through the laborious ACAT transfer process.
The biggest challenge, however, relates to revenues. Quite simply, you can expect them to decline. The size of the drop, of course, depends on how much of your business comes from commission-based revenue, since you'll probably lose some or all of it when you make the switch. If you were an OSJ at your b/d, your revenues will take an even bigger hit.
Annuities and insurance-based products are the trickiest to deal with. “The thing that keeps many people in a transactional capacity is variable annuities, because they don't know what to do with them,” says Winn. You should be able to convert them to a fee-based alternative. Trouble is, there's also the matter of timing. For one thing, thanks to market volatility, the underlying value in annuities has declined and “you don't want to lock in a loss,” says Winn. Or you might find there's a high contingent deferral sales charge. As a result, in some cases, you may have to give up that revenue entirely.
As for mutual funds, it's relatively easy to transfer them to fee-based alternatives. “You simply go from the retail world to the institutional world,” says La Spisa. Still, there are tax consequences that need to be taken into consideration. As for individual stocks, you can simply charge a fee for making trades.
To a certain extent, there's a delicate balance. On the one hand, you'll keep more of your revenues, since your b/d no longer will claim a percentage for your payout. On the other, your overhead expenses will rise just as you lose some of your commission-based business. Usually, however, advisors don't say goodbye to their Series 7 unless commission-based business is no more than 5 percent to 10 percent of revenues. Otherwise, you'll need to take steps to wean yourself away from transaction-based work until you reach that tipping point.
Once you've made the switch, expect it to take a year or so until you've made up for any lost revenues. There are exceptions, of course. When Dent moved to fee-only, about 5 percent of his revenues were from commissions. But, without a payout, his cash flow rose. While increased costs ate up about 5 percent of that gain, he still grew revenues by about 5 percent almost immediately.
As for La Spisa, he lessened the blow by an arrangement with his b/d. Knowing he might give up his license one day, several years ago he negotiated a contract through which the b/d agreed to pay him revenues from commissions for six months after he made a transition. “It was a nice cushion,” he says.
Ultimately, after the first year, according to a number of practice management experts, most advisors end up deciding the switch was worth the effort. When advisors give up their Series 7, there's usually no remorse, says Furey. “I don't ever recall hearing someone say, ‘I wish I'd kept that license.’”