That’s the million dollar question - sometimes more - over a lifetime.
Payout is a huge factor in our business, and a number we think we all know as an employee at a big firm. But when you're independent, there are a lot more moving parts and it can be complicated to calculate.
I think a lot of the misconceptions around payout revolve around it being too good to be true. It might be one of the reasons you didn’t explore independence or learn more about it in the past.
At a fairly high and accurate level, I want to review the set of factors that will determine what you might net if you were to take your existing practice and do the same thing in an independent model.
What I'll try to do is discuss each factor, and I'll talk broadly because each situation is different. If you're independent, you have more control of these variables, which is something I'll discuss in each section.
I'll probably do a separate discussion of why that control is so valuable, but today we'll just talk about the numbers.
Gross Payout Estimates
Depending on the firm you use and how you structure yourself, the top line gross payout can vary widely. In general, if you’re in a true independent model, you should be looking to gross at least 80 to 90%.
That's assuming you have a somewhat viable business. Let’s say you're doing at least $150,000 to $200,000 gross revenue, or that you will in an independent model.
The fixed costs are a bigger issue if you're below those levels. But there's some minimally viable level where these numbers make sense. I’m going to talk more about the $300,000 to $350,000 production level because it tends to be where you can make a reasonable living in most employee firms.
However, at that level, depending on the firm you're at, you may be treated like a second class citizen. That's why I focused there; the numbers get more attractive as you go up the scale.
If you're doing a million and a half in production, the numbers are insanely beneficial, and if you're doing a lot less, then the fixed cost might be an issue. But we'll focus on the midrange.
Let's assume an 85% top line gross payout, as that's very reasonable from my experience, both as an advisor, and in supporting other advisors.
One of the big (and accurate) things the detractors of independence point out is you don't really net 85%. That’s like saying if you gross a million dollars, you don't take home a million because you have to pay taxes. No kidding.
The point is you get 85% of your revenue to start with, and then you figure out what you have to pay for. That's what I hope to help explain in this discussion.
Two Biggest Expenses to Account For
The two biggest expenses for most of us are staff and office space. One of the beautiful things about having an independent practice is you have almost complete control over these two variables.
I know plenty of people who have “zero” down for office or occupancy cost (or effectively zero). They might deduct a home office and the prorated cost of that on their taxes. But compared to cash out of pocket, it's essentially zero.
They do their own administrative work, though depending on who you talk to, that may or may not be the best decision. But there are plenty of people happy to do the administrative work and not have to outlay any cash to keep their practice going.
The Cost of Hiring Help
On the flip side, you can spend as much or as little as you'd like on staff or office space. If you have a $327,000 production, you can hire 6 assistants if you need to. You can hire 3, you can hire 2, and you can pay him or her whatever you like.
You could go outside these ranges, but this is likely the amount of outlay you need to keep the practice growing without being bogged down. This isn’t recommended for someone trying to grow at a super rapid pace through a labor intensive marketing campaign.
This is your run of the mill practice. A good rule of thumb for staff is probably somewhere between 5 and 10% of your gross revenue. If you look at an employee firm, for every million dollars of production the firm might be doing, it’s more like 7 or 8%, possibly more if you factor in employee costs.
I think 10% is on the high end, and 5% would be okay if you're doing $320,000. That equates to about $16,000 per year, which can easily get you a shared assistant with somebody you know and trust, another advisor, or virtual assistants. You can get more than enough help to sustain a business of that level.
Again, I'm also assuming you don't have an overly labor intensive business. You don't have a niche requiring tons and tons of paperwork on an ongoing basis. You might have some transactional business, but it doesn't require a lot of administrate activity all the time. That makes 5 to 10% a good rule of thumb.
Results may vary and that’s largely driven by what you want to accomplish, which is one of the primary benefits I see and have in my own practice. I get to make the call for what I think fits me best. I can also change that decision anytime I want.
The Cost of Office Space
The next item would be the office or occupancy cost. I would use a 5% rule of thumb for that. In other words, let's use my $320,000 or $325,000 production against $16,000 per year. In most parts of the country, that will get you a decent office.
If you're solo with no assistant, you probably don't even need to spend that much. If you have staff and you really want to dress up your image, you might spend a little more, but that will vary.
5% of gross would be a good rule of thumb. While it does vary, it won’t be way off 5% unless you do something outside of what 80% of advisors normally do.
Those are the two main costs: 5 to 10% for staff, if you have any, and 5% for office space.
I'm trying to simplify here, so as we get into the operational costs, you'll have to add in things if you think they're essential to your business.
The Cost of Health Insurance
The next question about expenses is usually, "How much am I going to pay for health insurance?" There's good news and bad news on this front.
The bad news is health insurance is expensive. The good news is you’ve probably already realized that with how much you’re paying. Most firms I'm aware of for advisors aren’t subsidizing it dramatically. They know we can make the kind of income where it shouldn’t be a deal breaker.
If we're paying $1,000 per month for our health insurance at an employee firm, that’s a lot of money, especially for the average person or family. However, with the kind of income we're able to generate, it's not something that should stop us from being in this business, whether we're an employee or independent.
Each situation is different. I've examined the details of large company benefit plans, and there's a marginal cost, but it's not as high as you think. You can investigate it if you're looking into the details and getting close to making a decision about a business model change. Just keep in mind it's probably going to be when you equate the payout, a small percentage.
For most of us, this probably won’t happen, but let’s say you have to spend $1,000 extra per month for health insurance. If that’s on a $300,000 practice, that's a 4% payout issue. It's important, but it's not massive.
That’s when you start to think about these things in terms of the gross payout differential that you start from. That's 30 to 50% depending on the situation.
You're going to give some of that back when you pay for your staff and your business expenses, including health insurance. But you're certainly not going to give all of it back. It’s a complex issue and something to keep in mind, but don't let it scare you away from exploring your options if you're inclined to.
There may be times when that’s a deal breaker and it doesn't make sense to make a change. But there are also independent model firms and platforms that will account for that. You might have a lower pay out, but there's a group insurance plan you can plug into.
If you talk to a good recruiter, the firms themselves, or someone like us, we can probably help you find that if necessary.
Self-Employment Taxes
Another big expense the detractors of the independent model focus on is self-employment taxes, which is a very good point. If you don’t know, Social Security and Medicare taxes together are about 7.65% of your net income.
However, as you should know, there’s a cap on the Social Security part of that. It caps out somewhere around $120,000 or a little less per year. Only Medicare continues to go up, and that's only 1.45% on each side.
One thing to keep in mind is you're going to pay both sides of those employment taxes as a self-employed person. But you're already paying one side of them right now.
As an employee, you pay Social Security and Medicare taxes regardless. You may have, say, 15.3% self-employment tax. You might think that’s a ton. Well, it’s actually half of that because you're already paying that. The cap on the Social Security tax makes that a fairly fixed number, too.
Whatever this year's Social Security tax maximum is, multiply that by 6.2%, and then add 1.45% of your total net. That’s the extra overhead, so to speak, of being independent versus being an employee.
As an example, if you're netting $100,000, that's $7,650 extra in employment taxes. You haven't hit the cap on the Social Security side yet, either. To net $100,000, you're probably grossing somewhere around $170,000. That works out to about a 5% payout differential, and that's at the high end.
If you're netting a lot more, when you hit that dollar cap on the Social Security tax, that becomes a lower and lower percentage. Remember, your net will be a lot higher when you're independent. When you start to net $250,000 and up, the percentage as a payout issue is going to start to go down, if that makes sense.
Hopefully that explains it's an issue, but you have to frame it in a way that accounts for the logic. Look at what you're doing now, not just the 15.3% that sometimes scares people away. It's not compared to zero, it's compared to half of that.
The Cost of Doing Business
The other main expenses you have to consider are what I call cost of doing business. That's your broker dealer and/or RA, licensing fees, technology fees, affiliation fees, errors and omissions, and other miscellaneous items.
That's a fairly big cost in this grouping. Then you have your general operating expenses: your phone system, your paper, your toner, your computer maintenance, and licensing and fees you typically incur as an independent.
It might seem like you have to pay for a lot, but it doesn't add up (on a percentage basis) to a tremendous amount of money.
Let’s say you're in that $300,000 to $400,000 production range, and you have some tools, but nothing outrageously expensive. To provide a baseline, you can probably operate your practice well for about $20,000 per year.
I’m using a dollar amount here instead of a percentage because one of the amazing things about being an independent model is your costs don’t go up. You don't pay more for research just because your production goes up.
If I’m in an employee firm producing $300,000 and a few years later I reach $600,000, guess what? I’m now paying twice as much for my staff, twice as much for rent, twice as much for research, and twice as much for financial planning software. I'm paying more for everything because there are little to no fixed costs.
Your Marginal Payout
An independent model is like a real business where you have some overhead you have to pay for. Once you've covered that, any revenue beyond that is going to be paid at your marginal payout.
Let’s say I'm doing $325,000 and I've covered all my fixed expenses. For the next $50,000 dollars of revenue, I don't have any real new expenses come up - maybe a slight amount of labor to service that extra $50,000 of revenue.
That $50,000 is essentially paid out at my marginal payout - that 85% top line number - because I've already covered my fixed costs. This analysis of a payout is very hard to do because it starts to go in your favor as you grow. To some degree, the opposite is also true.
If your revenue shrinks, your payout is going to decrease because it's coming off that marginal revenue. However, you can also control your costs more. In a worst case scenario, you can divest of staff, office, and software if you need to go into your shell.
The point I want to make is the marginal payout isn’t what you really net; what you net is at the margin when you have extra revenue. In this scenario, if you get $10,000 in commission or fees, you get $8,500 bucks to your bottom line. That's a real number at the margin.
A Realistic Scenario for Payout
It’s very difficult to envision a scenario where you’re producing $250,000+ where you're not netting at least 15 to 20% more per year in terms of payout. If you're running a reasonably efficient practice, but you’re investing money in staff (even if it’s shared or part time) and in an office, 65% is a reasonable target given all those factors.
Of course, it could be less depending on how you set things up. It could be more if you use technology efficiently and don't need staff, if you have a virtual office solution, or if you have a home office solution. Then it could be as high 70%.
Conservatively speaking, I've used that 15 to 20% number. When you go through all the little details, you want to see those numbers.
What are the miscellaneous costs? What do they look like, what are the gotchas? Any firm, recruiter, or friends and trusted associates can help you run those details at any particular firm or arrangement within a given platform.
Is it Worth It?
Here's the way I look at it. Sometimes that 15% doesn't sound like it's worth enough to move. Let me re-frame that a little and give you some thoughts.
At an employee firm, when I say 15% better to be independent, I'm including - and adding back in the value of any deferred comp - 3 to 5% a year, maybe more if you're at the higher end of the spectrum with production.
These economics work a lot more in your favor. Some are focused on that middlerange where you might get some deferred comp, but it's not likely to be a huge percentage of your gross. That could be 3 to 5% percent, and again, that's usually of your net.
You can do the math. Yes, it's nice to have all these little add-ons, but what are they really worth? Add up the value. Do you have a 401(k) match? If you're contributing $8,000 per year, and you're getting matched on half, that's great. You’re getting a free $4,000 per year.
However, if you're grossing $400,000 of production, that's only 1% of your gross - it's a 1% payout improvement. I think behavioral finance tells us we get more excited about this 50% match on our $8,000, but if someone said, "We're going to give you a 1% payout bump," I'm not sure anyone would care.
Firms are going to frame things to their benefit. They're going to say, "We're paying you five ways." But you've got to add all those up and figure out the total value. There's one thing I can just about guarantee: the revenue you're getting paid isn’t five different ways, it's coming from one source, and that's the revenue your practice generates.
You can add in limited partnership, bonuses, any paid trips, and any kind of revenue. If you add all these in and do really a hard analysis, the 15% increase in payout is a very good, low-end estimate.
How the Numbers Play Out
Let’s look at an example. You're 40 years old and you're going to do this for 20 years. If you're grossing $300,000 even and you have a 15% payout improvement, by my math, 15% of $300,000 is a $45,000 a year improvement, which is pretty dang good!
Depending on your situation, that could be the difference between saving $5,000 per year and saving $50,000 per year for retirement. Or take the $45,000 marginal and enjoy $15,000 of it and save the rest. Whatever fits for your situation. The bottom line is, it's a nice difference on a year by year basis.
That's not even the most valuable aspect of it. In our business, you should be able to run some sort of future value calculation. If you take that $45,000 a year and earn 5% per year on it for 20 years, you’ll create around $1.5 million of value.
$1.5 million of value for doing the same business with a reasonable production level. Again, these numbers scale up. If you're doing $900,000, that’s a $4.5 million dollar difference over those 20 years. That doesn’t even take into account the value of your practice if you choose to sell it when you retire.
I don't care what goes on, it's almost impossible to fathom a point where an employee firm would pay you as much or anywhere close to what you can get for your practice on the open market as an independent.
The employee firms and wirehouses are starting to realize they need to do something to keep you in your seat and make it just good enough so you don't leave. But I don’t think they're going to do anything more than the absolute minimum to get people to stick around.
There are some other discussions I've had about the inherent flexibility (when you get to that point) of how you can step back from your practice. You don't have to sell it outright. Almost all those options are hard to replicate in an employee world. It's difficult because there’s more red tape.
I looked at these numbers backwards and forwards for several years as I wasn’t sure what direction I wanted to take when I went independent. I tried to factor in growth, I tried to factor in if I “cash cowed” it and didn’t want to grow it all, or if I wanted more of a "lifestyle practice" where I took care of my existing clients and a few referrals.
I've done something in-between, which I can talk about separately, but my practice has grown nice and steadily. I've had the time, energy, and flexibility to create a whole other business. This venture could be another business its own.
Bottom line is the payout itself can be life changing. Again, 15% is low; it can increase to 20 or 25% depending on your situation, and as you grow, the economics get even better.
I hope that helps. Let me know if you have any questions.