Some people ask me: what's the minimum amount of production I need to do to set up an independent business? I think that is a great question because there's a lot of misinformation about what that number really is.
Certainly to set up a practice that looks like a wire house, you will need a pretty good amount of production, but that is a big qualifier. If you just want to be able to make a living and are willing do a lot on your own, I think you will find the number is a lot lower, and I'll walk us through the numbers here shortly.
First, let’s talk about the two main types of independence that you want to think about, and I think one of them fits a lot better at the lower end of the production scale.
So the two main ways you can go independent would be to set up your own RIA (Registered Investment Advisor firm) or you can affiliate with an independent broker/dealer firm that has it's own corporate RIA, much like the employee firms do.
An RIA of your own would involve setting up a legal entity that registers with your state because we are talking smaller asset levels. If you have a $100 million under management of advisory assets, then you would set up an SEC registered advisory firm RIA.
But to answer this question, I think we can assume that setting up an RIA probably, for most of us, is going to be too costly. I am assuming we are talking about someone that is an employee at a firm, not starting from scratch, doing financial planning for a flat fee.
To affiliate with an independent broker dealer, there is a very low bar--relative to wirehouses--to the revenue needed to maintain an affiliation. I will use the example of $100,000 of gross revenue. The reason I am going to use that is because it is enough to probably make a better living than you make at an employee firm, even with slightly higher production, so it will account for not 100% retention during a transition. In general, unless you are fairly new in the business, it may not be worth your while. You can adjust the numbers that I'll propose for lower production amounts so you can see what that nets, but I think at that point you may be better off just finding someone to work for and bringing some clients.
First, I recommend that you look for a broker/dealer that supports the lower end of the production scale. If a firm has a $100,000 minimum and you think you can do $120,000, I would recommend looking elsewhere, because otherwise you are going to run into the same problem that people have run into at employee firms. Where at a Merrill Lynch if you don't do $300,000 or $500,000, or a $1 million, or whatever they decide the number is in a given year---you are going to always be worried about their number(s).
Being independent is great, but I think one of the main benefits should be that you don't have to worry about someone else's number for your business. You get to decide what is an acceptable level of income for you--and no one else.
For example---you may talk to an independent model firm and think it is the best platform possible. But if they tend to attract larger businesses than yours, do your homework and ask a lot of questions before making the move. You don't want to be the $495,000 producer at a great firm that you learn (too late) has a $500,000 production minimum that has adverse consequences for missing.
Obviously, if you are at the lower end of the size spectrum you tend to not have as much flexibility. Regardless, I strongly recommend you look for a firm that is willing and able to support a business that is similar to what you expect to have upon going independent.
That is even if you plan to grow, because I think you want to make sure you have enough runway, time, and flexibility to do it on your terms and not someone else's. So look for a firm that is happy to have you as a customer/advisor (broker, rep, or agent etc.) and then start to look at their numbers.
I'll use the numbers from a firm I am affiliated with because I know them fairly well. Given the world we live in, I would assume you can find other options that would be similar, because it is a competitive world, and I think the firm I am affiliated with is still willing and able to support this kind of business. So we'll go from there.
So if you are affiliated directly with my firm and use their home office supervision, you will have a 90% payout on mutual funds, advisory business, annuities, and most things that are not stocks or bond transactions.
So if you don't have any stocks or bonds transactions or very little, you can probably assume you are going to make close to 90% as a gross payout. If you do a lot of stock and bond trades it might be a little bit lower, but let’s use 85% for an average. I think that's pretty reasonable estimate. So 85% topline before expenses.
So the main expenses you would incur would be for the home office supervision; it's about $5,000 a year. The other big batch of cost would be licensing, state licensing fees, firm affiliation fees, the technology, and the E&O insurance is also a large one. That is about almost $3-4,000 a year.
So there's a bunch of costs of doing business that aren't really optional, and those tend to run around $10,000 a year as a good estimate. That's rounded up a bit, but that's a good number that includes a few bucks for your firm CE.
Remember: if you are not used to being independent, you are going to pay a la carte for various things that you don't write checks for now. You’re going to pay for state licenses, so you are going to be careful to only pay for states you do business in, and hopefully you do enough business to offset the costs of the license, or you may decide that the clients are not a good fit if it costs you money to do business with them.
Then I have a category for miscellaneous, so miscellaneous business expenses could include a phone, maybe some office supply-type expenses. I just put that at $5,000 a year. For some people that may be too high and for others, if you are going to do marketing, you could spend as much as you want on marketing or as little.
So those are the main categories. $5,000 a year for home office supervision, $10,000 a year for what I call the “costs of doing business,” and $5,000 for miscellaneous.
The two biggest costs for many practices, including mine, and most bigger, larger businesses in our industry are going to be your staff and your office. So at the $100,000 production level, I would probably try to, unless you have a really solid and direct plan of growth, start with a home office and no staff, because if you spend money on those two categories, you're going to eat into your profits.
You might be able to find a fairly inexpensive office that could help with perception if you are trying to grow, especially when you are moving over. I have subleased from another adviser in a nice building; it's not a huge office, but it’s 130 square feet---big enough for one person for sure. I have done that for $500 to $600 a month for six years, and it's 2015 as I record this.
That could be something you might want to invest in for perception if you think that would help. As you grow, it is easy to overcome that expense, or if you get settled and realize you just want to maintain your existing clients and take referrals, then you can always drop that later. I think I can drop my office now and it wouldn't matter to my clients.
So my example is zero for both of those expenses, for staff and for office.
So to recap, we're assuming $100,000 in gross revenue with an 85% payout on average, which is $85,000 of revenue before expenses. We're assuming $5,000 for home office, $10,000 for the costs of doing business and licensing, and then $5,000 miscellaneous. That's just $20,000 of expenses, so that would net you $65,000 a year.
So as I looked at these numbers several years ago when I learned about the independent model, I used a slightly higher revenue because I was an employee and I had to do 180K or what ever the number was. I figured if I could do 180 I might as well do it for myself. That was one of my first thoughts as I did these numbers, and they were pretty nice compared to the 40% or so I would net at that firm when I was doing 180K.
Which by the time I had left my trailing-12 was $189,000. So that's noteworthy or coincidental. But anyways, the point is making $65,000 a year working for yourself so you can own your time. That's not a bad gig compared to where you may be now if you are asking the question, “what's the minimum?” That's the great news, and I think it is a phenomenal option to consider, and you have to be willing and able to do all the paperwork yourself. You are going to have to keep yourself accountable, or you are going to see a lot of problems and prospective headaches from your firm.
You want to make sure your compliance paper work is in order. That's very doable, especially if you don't have hundreds and hundreds of clients that make up that revenue. If you have 100 clients or 200 clients that make up that book, and they're relatively easy to deal with, and you enjoy them, I think there are a lot worse ways to make $65,000 a year. I think that's not a bad deal.
So one major thought to add to this though. I think probably the biggest question is: how confident are you that you would retain $100,000 revenue or whatever you think you will retain? Because keep in mind that the revenue I'm talking about on the top line is a lot like a mutual fund performance: you don't get your past performance; you only get what you bring over. So that's your future performance.
So if you're at a bank and you're doing $400,000, but every client of yours has been brought to you by the bank, you probably will assume a worst case scenario unless you've been there so long you know everybody is with you, not the bank. I use banks as an example because that is typically where we see lower retention rates, because they start as bank customers and may or may not become your clients over time. I see a huge correlation with who developed the business and the retention rate when someone goes independent. I just find that to be a huge, huge determinant. So make sure you have a built in a buffer because otherwise you are going to come over, go independent, and then be looking for another job, and that's no fun.
Unless you're comfortable or have a spouse that makes good income, or maybe you're fairly young and have very low expenses, if you run those numbers at $50,000 in revenue and under or overestimate, it's not going to work out too well. 85% of 50K is 42.5K minus $20,000 expenses so you're down to $20,000 to $25,000 income range.
Which again, if you want to treat this as a part time job, maybe that works. Let's say it doesn't, and you need to make $65,000 a year.
Well, you have an asset then at $50,000 of revenue, and you could sell that block of business to someone else and they'd be happy to pay you somewhere between $50K and $100,000. So at a minimum, I have told people this before: these corporate jobs working at Fidelity, or Schwab, or Ameritrade, or any bank and be a bank broker or wherever it is that makes a very safe way to make $65,000 - you can always go do that later, and you will have basically a years' worth of salary up front if you have a $50,000 block of business for example.
So point is: if you can move anybody, you'll have something that is valuable, and you'll have to have that conversation with clients and make sure it's a smooth hand off so they feel taken care of because it is not just a widget you're selling, you're selling a relationship, so you have to make sure that's done well.
So point being: you have an asset that you can then move on with, and I have seen people do that that had a relatively small practice and a better deal came up, and a guy I know went to work for USAA and had phenomenal benefits. He had young kids and tried to build out a practice and add people when an office didn't work out like he hoped, and about five years ago went to work for USAA and is enjoying a great career there. So that's worked out well, and he got money for his practice and lived happily ever after hopefully. The other party, the buyer, did too hopefully.
Hopefully that answers the question of what's the minimum production to go independent. The more the better, but it can certainly be done at a fairly modest level. So let me know if you have any questions.