The Metamorphosis

James Daniel knew what he wanted, and it was more independence. So, last year, after three years with Ameriprise in Alpharetta, Ga., Daniel decided he was ready to make The Big Move: He would drop his Series 7 and go out on his own as a registered investment advisor (RIA). But not long after he started putting the wheels in motion, he began running up against an unexpected — and tricky — conundrum. As long as he was a commissioned rep, his livelihood depended on bringing in a constant stream of clients. At the same time, he was loath to pitch products to new accounts when, in a matter of months, he would be giving up the life as a registered rep and asking the same folks to switch to a fee-based service.

What to do? Daniel simply stopped trying to sell to new clients. “My numbers dropped like a rock,” he says. To avoid facing angry questions from his manager, he took to staying out of the office as much as possible. To make matters worse, when he opened his new business in March, it took six weeks to get all his accounts set up. “When you decide you're going to make this transition, you have to know your sales are going to plummet at first,” says Daniel, a CFP whose practice, called simply The Advisory Firm, now has about $12 million in assets under management.

Unless you've been living under a humongous rock, you know that more and more advisors are following the same path as Daniel and are opening up their own RIAs. In some cases, like Daniel, they want the independence and the ability, as they see it, to serve their clients' interests more effectively. In other cases, they're following the money as an increasing number of high-net-worth clients choose RIAs.

Not everyone is giving up a Series 7, of course. Of the 10,000 or so RIAs registered with the SEC, about 5,700 are what's known as fee-only, according to Philip Palaveev, a senior manager at Moss Adams, a Seattle consultancy specializing in financial advisors. But whatever route you choose, you're likely to encounter a host of tricky problems and stumbling blocks. Here's a look at five of those problems and what you can do about them.

No. 1: Your revenues drop — at first.

As Daniel discovered, your income can take a big hit when you form your own RIA, especially if you go completely fee-only. RIAs who choose to keep their Series 7 can affiliate with an independent broker/dealer and make their money from a mix of fees and commissions. But fee-only advisors give up their Series 7 and any commission-based income they used to get. Plus, like Daniel, you may wish to cut down on your commission business before you make the move. And, it takes 30 to 90 days to move the bulk of your assets over to your new firm. Even if you keep your Series 7, you're also likely to face a cut in revenues, at least if you're really serious about transitioning the bulk of your business to fees. The result: Most advisors who switch to RIA practices experience a drop in revenue of about 30 percent in the first year, according to Palaveev.

As long as your business continues to grow, however, you should be able to start catching up by your second or third year. That's partly because you don't have to give up any of your revenues to a b/d anymore. Also, you can probably focus more on your clients and, as a result, they're likely to increase the level of assets you manage for them.

Case in point: Ten years ago, Janet Press started her own financial-planning firm in Elmsford, N.Y., with most of the business coming from the sale of mutual funds. Then, three years ago, she decided to change her approach so that the bulk of revenues would be made from fees. So, she joined Fusion Financial Network, an advisory network that provides office space, marketing advice and other services to advisors, and is affiliated with NFP Securities, a national network of independent advisory firms headed by Jessica Bibliowicz. She stopped doing new commission business and began concentrating on fee-based accounts. The result: Her income was cut in half. “I held my breath and rebuilt the practice,” says Press.

What happened? After about a year, she started recovering revenues. Now, they're higher than before she made the move. Annual fees of 1 percent to 1.3 percent on her $44 million in assets under management account for about 70 percent of revenues.

Art Day took a different tack. Day left UBS last April to launch Day Hagen Financial in Sarasota, Fla. He chose to keep his Series 7 with a small b/d so he wouldn't have to lose about $100,000 in trailing income. “I wasn't in a position to give it all up right away,” he says. Day, who has about $125 million in assets under management, plans to drop the b/d entirely in about a year.

No. 2: You have to take care of infrastructure matters yourself.

All independents must handle a variety of complex tasks their old employer used to take care of for them, from marketing to compliance. One of the most important areas is technology, especially for fee-only RIAs who aren't affiliated with a b/d. Folks who hold onto their Series 7 get a host of technology and back-office support from their b/ds — for a price, of course. Fee-only advisors, on the other hand, are completely on their own. While custodians like Schwab and Fidelity will provide client statements, you have to choose — and pay — for the bulk of your software. That means tools for everything from client performance reporting and account aggregation, planning and modeling to investment evaluation. “Most advisors don't realize how much technology they're provided with when they're with a wirehouse,” says John Nersesian, a managing director with Nuveen Investments in Chicago.

But, there are ways around the problem. You can join an existing RIA, or you can do business as part of a corporate RIA connected to a b/d. In that case, you will have to pay a percentage of revenues, typically about 10 percent, to the b/d. Day chose to affiliate with Raymond James' Investment Advisory division. The company provides him with soup-to-nuts technology and back-office support in exchange for a small transaction fee charged to clients.

No. 3: You need to create a new pricing model.

RIAs, of course, charge either a flat hourly rate or an annual fee based on the amount of assets under management. But, in reality, it's not that simple. The fact is, you're running your practice on a completely different business model. And that requires taking into account a number of factors you may not have considered before. To a certain extent, it's all about time. “Many advisors don't even try to estimate the time commitment they will have to make to serve clients and [measure] what the actual cost of each relationship will be,” says Palaveev. That's a mistake, because two clients with the same level of assets may not contribute equally to the bottom line if, say, one calls three times a month and the other never calls at all. In addition, according to Nersesian, advisors often underestimate the revenue per client they need to generate and the number of clients they have to serve.

The key, says Nersesian, is determining “how many clients I can afford to work with, how much time I spend with them and at what price.” Your plan of action might include anything from changing your basic rate to revising the number (or even the type) of clients you serve — a complex equation that, most likely, you won't get right at first. In fact, according to Nersesian, you can expect your fees to be a work in progress for the first year or so. He points to an advisor who left Merrill Lynch three months ago to form his own RIA. “He's still figuring out how to price the business to make it a viable enterprise in the long-term,” he says.

No. 4: You face new regulatory and compliance hurdles.

When you're starting an RIA, you enter into a whole new world of red tape. RIAs with under $25 million in assets have to register with their state securities regulator; those with more than that amount must file a Form ADV with the SEC. (The SEC, saying it is stretched, is considering raising that amount to $50 million or more.) It's a long process with arduous forms that are easy to fill out incorrectly. Daniel, for one, says it took four months before he was approved. And, depending on the state you're operating in, you can expect continual back and forth if you haven't dotted all your I's. Eve Kaplan opened Kaplan Financial Advisors, a Berkeley Heights, N.J., RIA two-and-a-half years ago and, last year, registered in New York. According to Kaplan, while she rarely hears from the New Jersey regulators, she has been asked by New York on many occasions to provide more information, ranging from a new code of ethics to all the income and balance-sheet statements for each fiscal year she's been in business.

That's just the registration process. You also face new compliance concerns, because you'll be responsible for that task on an ongoing basis (that is, if you're not affiliated with a b/d). Under new rules, the SEC requires a yearly audit of RIAs. It's a time-consuming process — and expensive. Total cost for setup and maintenance of compliance systems: about $20,000 to $30,000 a year, according to Palaveev.

Failure to follow the rules can land you in big trouble, of course. Dawn Bond, who runs Compliance Advisory Services in Atlanta, has a client who recently discovered that, although he had registered the firm, he had neglected to register all his advisors. As a result, everyone had to retake their exams — and the firm had to pay about $2,500 in back fees and penalties.

One way to deal with the issue is to bite the bullet and hire outside specialists to take care of these tasks for you. J. Patrick Collins Jr., who launched Greenspring Wealth Management in Towson, Md., four years ago, paid a lawyer $5,000 to take care of registration, among other issues. “It was the best money I ever spent,” he says.

No. 5: You get lazy.

In an odd twist, one of the attractions of life as an RIA — the fact that you don't have to keep developing a large client base to make money — can also backfire. “Since revenue regenerates itself, many advisors become complacent,” says Palaveev. “And that eventually starts hurting their growth.” In other words, you may no longer be a product salesman, but you're still in sales.