As RIA registration consultants, we continue to see an increase in the number of new registered investment (RIA) firms being started that offer financial planning services. The accessibility of better and cheaper technology coupled with increased consumer demand for holistic wealth management services means that today is a very intriguing time to start a new financial planning firm. Some of the key considerations when starting a new firm today include: properly registering the firm as RIA, deciding whether to offer portfolio management services, choosing a revenue model, and selecting the right software and technology.
Registering as an RIA Firm
Depending on the firm’s projected regulatory assets under management (AUM), a new financial planning firm will be required to register as an investment advisory firm with the relevant state(s) or the SEC. In particular, it’s important for financial planners that are considering starting an RIA firm to carefully understand how to properly calculate regulatory AUM. Often, a financial planner may provide general advice on a client’s investment portfolio, but the assets of that client’s investment portfolio may not count as true regulatory AUM depending on the nature of the engagement.
Every RIA firm also needs at least one individual registered to the firm as an investment adviser representative (IAR). Regardless of whether the firm is registered at the SEC or state level, the individual IAR registration process is managed exclusively by the states. In the vast majority of states, an IAR is required to have passed the proper qualifying examination(s). However, financial planners that hold the Certified Financial Planner (CFP®) professional designation are not required to take any additional exams as they are automatically qualified as an IAR.
In addition to filing the required documents with the proper jurisdiction(s), a new financial planning firm will also need to ensure that it establishes a compliance program, designates a Chief Compliance Officer (CCO), and creates a tailored policies and procedures manual and other required firm documents.
The cost to start a financial planning firm will vary based on the size of the firm, but we generally find that a solo-advisor RIA firm can be started for around $8,000 upfront which includes our compliance consulting fee to assist with registering the firm and creating the mandatory compliance documents.
Choosing Whether to Offer Portfolio Management Services
One of the key decisions for a financial planning firm is to whether it will also be providing portfolio management services. In our experience in helping start RIA firms, we find that the majority of financial planners do offer portfolio management services as part of their holistic client service offering. Furthermore, if the firm is going to offer portfolio management services, the next decision is whether the firm will directly manage client investment portfolios or instead outsource investment management to another RIA firm or other turn-key asset management platform (TAMP).
If offering portfolio management services either directly or by partnering with a TAMP or other third party money manager, a single or group of custodians will also likely need to be selected. Some key factors to consider when selecting a custodian include the technology platform, trading tools and execution capabilities, and access to third party portfolio managers.
Choosing a Revenue Model
As RIA registration consultants, we see investment advisory firms that offer financial planning services charge for their services in a variety of ways. Some of the most common include:
- Percentage of AUM
- Flat annual retainer
- Flat quarterly retainer
- Flat monthly retainer
- Hourly
In our latest 2015 survey of over 1,200 RIA firms that we provide RIA compliance assistance to, we find that the percentage of RIA firms that use each type of compensation method are:
- Percentage of AUM: 91%
- Fixed fees: 42%
- Hourly: 47%
Please note that the 3 figures sum up to over 100% as the majority of RIA firms offer more than one type of fee model.
Of course, firms that do not offer any form of portfolio management services are quite unlikely to bill on a percentage of AUM and will instead exclusively offer financial planning services on an hourly or fixed fee basis. On the other hand, firms that do provide investment management services will frequently bill on a percentage of AUM and include basic financial planning services as part of the annual AUM-based fee.
However, AUM-based fees may not be a viable option for financial planning firms looking to serve younger or less affluent clients that do not have a large amount of investable assets. We often find that these firms may charge a flat financial planning fee for financial planning services and then a separate AUM-based fee for any additional portfolio management services.
While many firms will include hourly financial planning fees as a service option, we are seeing fewer firms emphasize this method as the primary revenue model. The rationale for this is that billing by the hour may cause the client to be hesitant to reach out to his or her advisor on a regular basis or lead to disputes over what was billable time. Furthermore, from a business standpoint, billing by the hour often creates a less consistent and predictable revenue stream and also leads to do additional administrative challenges and expenses in order to track and properly bill by the hour. Instead, many financial planners will tend to only use the hourly billing method for specialized services above and beyond the norm.
Choosing the Right Software and Technology
In our latest 2015 survey, we found that nearly 65% of firms with less than $50 million in AUM that offer financial planning services utilize a financial planning software system. For such advisory firms with more than $50 million in AUM, this figure climbs to over 80% The most popular RIA financial planning software solutions are detailed in our Guide to Financial Planning Software for RIA Firms.
In addition to or in lieu of financial planning software, most new financial planning firms will also invest in other technology. The key technology decisions for a new planning firm are:
- Choosing what types of RIA technology are needed
Financial planning software aside, most new RIA firms do not need advanced portfolio management and reporting systems. This is largely due to the fact that we see many financial planners looking to provide simplified reporting. Simplified generally means showing a consolidated personal balance sheet rather than a 20 page detailed investment performance report. As such, we generally find that the key technology needs for a new financial planning firm that has recently started an RIA firm are:
- Customer relationship management (CRM) software: This will typically serve as the central hub of the firm’s operations and include all relevant client and prospect information.
- Document storage: A system to store all client files.
- Automated fee billing: Whether billing on AUM or on a retainer basis, a system that automatically calculates fees and generates billing invoices.
- Automated account aggregation: Automatically pull in a client’s investment, checking, savings, credit cards, and mortgage accounts.
- Client portal: An online portal to share basic client reports such as a personal balance sheet or simple change in investment account values over time.
- Client information gathering: An automated way to gather client suitability and other relevant information in order to create an investment policy statement (IPS)
- Setting a monthly technology budget
The pricing structure of cloud-based software greatly benefits a new financial planning firm. Gone are the days of the large upfront costs of purchasing software as such upfront costs have almost entirely been replaced by monthly subscription fees. We generally recommend that a new financial planning firm budget at least $600-800 per month per financial planner on RIA-specific technology.
- Choosing whether to invest in a platform or individual solutions that then need to be integrated
This is primarily a question of personal preference. Some more tech-savvy financial planners may wish to demo a number of different providers in each category and then build their own custom suite of integrated software solutions. This approach can often lead to greater flexibility but can also create a challenging maze of integrations. On the other hand, others starting a new RIA firm will look to utilize a single platform that already includes the key technology components and thus no tech expertise is necessary.
Be sure to check back soon in the coming months as we further discuss the economics of operating a financial planning firm along with some of the key RIA regulatory and compliance considerations.