One spring day two years ago, Peter Haack paid a visit to a friend, a broker working for Salomon Smith Barney in New York. Haack, who had been running his own suburban Chicago-based independent practice for 11 years, was amazed. “He had access to all these resources — specialists in estate planning, insurance, retirement planning — I could never get as an independent,” he says.
Haack had already been wrestling with the problem of how to offer clients a broad array of such services. On top of that, he was growing tired of all the time he had to spend running the business — paying the bills and the like — instead of actually practicing financial planning.
One thing led to another and, a few months later, Haack — once an apostle of the independent advisory life — decided to make a switch: He joined Smith Barney, focusing on managed money, his forte. He has never looked back. “I spend all my time with clients, and I'm making more money,” he says. “It was the right decision.”
Sure, going independent has its allure. You have the potential to earn a higher payout; you are the undisputed owner of your own book; and, say you want to take a Tuesday off to hit the links, sure, go ahead, you're the boss. But nirvana it's not. As is often the case, there are tradeoffs: While you may dislike your firm for its fixation with monthly production numbers, you may also depend upon the resources the wirehouse brings, such as computers, office equipment and other support services. When you go off on your own, you are saddled with the time-consuming details of running a business that you never had to worry about. When you go it alone, no longer are you able to focus on investments exclusively; you need to become well-versed in buying insurance, negotiating office leases, buying computers and service contracts and finding and hiring various consultants.
That doesn't mean you shouldn't take the leap. It's just wise to be prepared. “Becoming an independent makes sense if you've thought through all the business issues,” says Mark Tibergien of Moss Adams, a Seattle-based consultant to the securities industry. “The transition can be a challenge.”
Owning your own business, of course, has its upside. But for many newly minted RIAs, the realities come as quite a shock. All those mechanical, mundane tasks you used to leave to someone else — buying paper, filling out applications, submitting forms, choosing a telephone system, paying the electricity bill — are now your responsibility.
“You end up spending an inordinate amount of time on trivial details you used to dump on your manager's door,” says Rick Peterson, president of Rick Peterson & Associates, a Houston-based recruiter specializing in the brokerage industry. Peter Haack is a case in point: He estimates that as an independent he spent perhaps one-third of his time in what he calls “non-producing activities.”
Such matters may become less time consuming as you fine-tune your operations. But you're still likely to experience frequent spikes of demands on your time, even later.
Consider Mark Bredin, who started his Bredin Investments in Malvern, Pa., after 22 years with a major wirehouse. Four-and-a-half years later, he only spends perhaps “a few hours a week” on administrative matters. But not always. He's now getting ready to hire another rep and, “I'm spending a lot of time preparing — getting the space ready, putting in equipment and training systems,” he says. It's meant a half a week's work for several weeks. “That adds up,” he says.
Fact is, when you hang up your own shingle, you've not just become a small business owner but you've become a small business owner in a tightly regulated industry. Compliance issues can be daunting, especially since at the end of the day you are responsible — not some branch manager or other executive up the company chain. You can affiliate with an independent broker/dealer for help.
Still, “You'll get guidance, but ultimately it's up to you to make sure it's done right,” says Tibergien. “You're in charge.”
In 2000, for example, Haack was audited by the SEC as part of the agency's standard procedure for evaluating the status of independent reps' Y2K compliance methods. Besides occupying a significant amount of his time, he had to hire an accountant, which cost him big money, to make sure he had done everything correctly.
Which leads to another point: Most independents realize quickly that they can't do it all alone, so they end up hiring help. “You find that you can either spend a lot of your time on these other things, or hire people to do it,” says Gerald Dewes, who started Investor Advisement Services in Williamsville, N.Y., two years ago after leaving John Hancock.
In fact, it's a constant tension: You need outside consultants for such services as investment research and access to money managers. But this comes at a price. Ultimately, “The only way to be competitive with your pricing is to reduce your own client fee,” says Haack, who had paid fees both to Lockwood Financial Services for manager research services and Charles Schwab for clearing activities. He estimates his profitability has increased 35 percent since freeing himself of those obligations.
If that weren't enough, there is the problem of “fee compression.” A decade ago, independent reps commonly charged a fee of 2 percent of assets under management; today, RIAs are charging around 1 percent to 1.5 percent, according to David Grau, a principal with FPtransitions, in Portland, Ore., who has handled the sale of many independent practices. That's partly because of more intense competition and because consumers have become more informed. But it's also because reps have increasingly had to seek out somewhat less affluent clients than before. “If you're investing $40,000 for someone, you can't charge a 2 percent fee,” says Grau. At the same time, with a down market, clients are less willing to pay high fees. “It's a bad combination,” he says.
Credibility is another key issue for RIAs, says recruiter Peterson. Without the comfort of that big wirehouse brand name backing you up, you're suddenly a one-man band of uncertain credentials. That certainly was the experience of Mark Bredin. “My old clients did not move as quickly as I thought they would,” he says. “They wanted to kick the tires first.” In other words, the client preferred to test-drive the advisor whom they had already been riding with. “They'd say they wanted to transfer their IRAs. But I didn't really want their IRAs,” says Bredin. Ultimately, about half of his 1,000 old clients made the switch, and transferred over the rest of their accounts, too. But, it meant that it took Bredin a good year to get off the ground, as opposed to the 90 days he'd been expecting. “Everything takes longer than you think,” he says.
An even bigger problem is extricating your clients from the jaws of your firm. Many wirehouses have stiff noncompete clauses, which the firms have in the past rigorously enforced with injunctions and temporary restraining orders. But with the new TRO rules, such disputes over who owns the clients — the broker or the firm — will have to be heard quickly. Either way, at a minimum, “They will have other brokers in the firm pursue your clients as soon as you make the announcement you're going to leave,” says Tibergien. To make the problem go away, you've got to cut another check. When Bredin quit, Merrill, his old firm, sued. He was forbidden to have contact with “any person who had been known to me while I was employed at the company,” he says. So, Bredin paid $10,000 to hire a lawyer to negotiate an out-of-court settlement, allowing him to approach his old clients.
In the end, perhaps the most difficult part may be how much less time you get to spend working with clients — the activity that got you interested in going on your own in the first place. And the work is even worse than before. “You come in early and leave late, every day,” says Bredin.
Result: a high degree of burnout. In fact, after 10 years, it's not uncommon for independents, especially those in their 50s, to decide it's time to cash in and do something else, according to Grau.
But despite all the problems, many independents are glad they made the move. Take Mark Bredin. His main objective in leaving was to veer away from sales, in which the rep is selling something to the client, and into the advisory business, which more closely aligns the interests of both advisor and client.
Further, Bredin wanted his book of clients to be — in no uncertain terms — his clients. “I didn't want to go through that change [to the fee-based model] and end up with something that wasn't mine. So, it's been well worth the effort,” he says.