Editor’s Note: This blog post comes to us from XY Planning Network co-founder Alan Moore.
When I launched my RIA in 2012, I was completely overwhelmed by the prospect of being a solo firm owner. I went from being a junior planner, only responsible for working with clients, to being the financial planner, investment adviser, compliance officer, marketing guru, tech-fixer, and bookkeeper.
In addition to wearing all of the hats, I was creating and implementing a process of providing financial planning services, and learning how to actually run the business. Even with all of this, my biggest fear was the investment management portion of the business.
I had always worked in firms that had investment experts, so I was strictly on the planning side of the house. The thought of learning how to manage investments, in addition to everything else, was overwhelming.
“What are my options for investment management?” is a really common question we hear at XYPN. There are actually a lot of different options out there, and choosing one when you first launch can be difficult.
Here are some the options available to you as new(er) firm owners:
Don’t Manage Investments
Remember that you don’t have to manage money at all. Investment management can be a very time consuming and complex process (especially if you don’t use third-party platforms for support), so simply eliminating the service all together can help save you a ton of time and energy. It will also keep your E&O insurance rates low, since trading errors aren’t a risk, and that might save you quite a bit in your first year.
Other than not wanting to spend the time, what are some other reasons you might want to not manage investments for clients? A few to consider include:
They might not need investment management. If you work with younger clients, recent graduates, etc. then they might not have assets to manage, so it simply isn’t a service they need.
You might decide that there are too many conflicts when it comes to managing money. Kate Holmes, founder of Belmore Financial in Las Vegas, is a financial planner that has chosen to not manage investments. She told me that her clients “like that [she doesn’t] have any conflicts when it comes to doing both their financial planning and managing their investments.”
Conflicts can arise in various situations. One example is if you work with a lot of military members or government employees with access to the TSP. Many would argue that those clients should keep their money in the TSP, while advisers managing investments have incentive to roll the money over to an IRA.
Another example is the infamous conflict that fee-only advisors are accused of having, which is whether to have clients pay down debt or leave money in their investment accounts. When you don’t manage investments, you don’t benefit from the client making the decision to invest more and keep debt which can help keep the advisors unbiased and objective.
Some advisors ultimately want to focus on providing financial planning services. While we will discuss some outsourced options below, some advisors don’t want to manage these outsourced providers either, and prefer to keep their business model even simpler.
For advisors that don’t manage investments, how do they help their clients with their portfolio? There are a couple of options:
You can simply direct clients to a low cost do-it-yourself custodian like Vanguard. Vanguard allows advisors to have view access to investment accounts (with clients permission of course) so you can see if clients have implemented your investment recommendations, though ultimately the control and responsibility is theirs.
You can use a technology platform like Blueleaf with built-in account aggregation to gain view access to your client’s investment accounts. This way you can view their IRA’s, 401(k)s, checking and savings accounts, etc. Note: If you tell them that I told you about Blueleaf, you will get two months free, and so will I.
Simply make recommendations as you see fit, and ask clients for statements on a regular basis (quarterly is likely preferred) so you can keep an eye on their accounts.
Partner with Another RIA for Investment Management
Advisors that prefer to focus on financial planning, and prefer to outsource the work that goes into investment management, might prefer to partner with an RIA that is passionate about investments. We all have our passion, and while I’m in the “I love planning and hate investing” camp, there are a lot of “I love focusing on investments and hate doing planning” camps out there.
If you look around, you will likely find a lot of firms that are willing to help provide investment management services. I’ve seen successful relationships structured several ways:
Prominent NAPFA member Bob Maloney is an advisor that is passionate about financial planning, but isn’t interested in serving as his clients’ investment adviser. He has partnered with an RIA that only provides investment services, and completely outsources the service. This means that the client is contracted with two companies: one to provide financial planning and another to provide investment management.
Clients pay Bob’s firm for financial planning, and the other RIA for investment management services. In addition, since both firms provide different services and aren’t competing, they are able to refer business back and forth.
Note that Bob actually pays the investment firm a referral fee which is calculated as a percentage of revenue that Bob receives from clients, to send him financial planning clients. Bob doesn’t receive any referral fees for sending the investment company clients.
Most incorrectly believe that organizations like NAPFA prohibit the paying of referral fees. NAPFA only restricts the acceptance of referral fees, not paying them, in order to avoid conflicts that would cause. They just don’t want their advisors to be incentivized to recommend one professional over another, and instead want the advisors to recommend the best professional for the client.
If you prefer to simplify the relationship for your clients, you can contract with an investment management firm to provide services to your clients. There is some crossover with this type of agreement and working with a traditional TAMP. By contracting with an investment management firm, you would have your clients sign a 3-way agreement between the client, you, and the investment firm.
As the financially planner that initially worked with the client, you would want to ensure that contracts state that you “own” the relationship meaning that you can fire the investment firm, and they wouldn’t be able to contact the client. With this type of relationship, you would typically oversee the work being performed by the investment manager, establish the clients’ goals which then dictates portfolio construction, and be responsible for client communication.
The investment manager would then handle all of the investment management related tasks, such as account opening, transfers, research & analytics, performance reporting, billing, rebalancing, etc.
Use Traditional TAMP
Similar to outsourcing to another RIA, advisors can choose to work with a traditional TAMP. I’m using the term “traditional” to differentiate from the newer technology-based TAMPs that have come into the market in the last few years.
A TAMP, short for Turnkey Asset Management Platform, is a fully outsourced investment management solution. TAMPs are designed to allow the financial advisors to outsource all of the work that goes into managing investments.
Every TAMP is structured differently, and provides a variety of services. When evaluating TAMPs, you should be sure that you understand:
Fee structure – There can be a lot of layers of fees, including custodial fees, trading fees, and underlying fund expenses, in addition to the fees to the TAMP itself. There might also be a la carte fees for services like performance reporting, billing, etc. Fees vary wildly, but most start at .35% of AUM and I have seen fees over 1% depending on services offered.
Investment philosophy – If you are a big believer in DFA, you can find a TAMP that uses DFA funds. You will find TAMPs available to support a wide variety of investment philosophies including market timing, passive, tactical asset allocation, and everything in between.
Additional services – TAMPs might provide an online portal for clients, assistance with filling out paperwork, performance reporting, and even para-planning services. Be sure you know what they offer, even if you won’t need it immediately.
Minimums – Most TAMPs requirement asset minimums. They will likely have a minimum level of assets that the advisor brings over, minimum assets that each client has with the TAMP (at a household level), and a minimum account size as well (for each account within the household). Be sure you understand these minimums, and ensure they are in line with your typical/ideal client.
Legal contracts – It is probably worth having an attorney review any contracts you sign with a TAMP. You want to be sure that you retain hire/fire rights when you partner with a TAMP, because they last thing you want is for your to fire your TAMP, only to have them contact all of your clients.
Use Technology-Based TAMP
New on the scene is a slew of technology-based TAMP services that is bringing down the cost of outsourcing investment management services. Many are leveraging technology originally produced to bring investment management services to consumers at very low cost, now developing platforms for advisors to better serve their clients.
As far as I know, all technology-based TAMP’s provide the same basic services including a rebalancing solution, reporting, billing, client portal, etc.
Here are some options if you’d like to go this route for your investment management:
Betterment Institutional (or B+) – Based on technology from their sister company Betterment, B+ provides an advisor-facing solution to outsource investment management.
You can elect to use their model portfolios, or build your own using their 12 preselected ETF’s.
Accounts are rebalanced daily, with no transaction costs, and have built in tax-loss harvesting capabilities.
All account opening and transfer paperwork is electronic, the client portal is super slick, and ultimately it allows you to get out of the day-to-day tasks that you don’t need to be a highly trained CFP to provide.
Fees are 0.25% of AUM (plus the modest expense ratio of the underlying index ETFs), with no account or advisor minimums.
The downside of B+ is that currently, you can’t ACAT in existing asset positions, meaning you need to sell all assets to cash before transferring to Betterment. Depending on your ideal client, this may or may not be an issue. B+ also doesn’t currently allow you to exclude assets from the model portfolios, so you aren’t able to hold cash or legacy assets.
Motif Advisor – Motif Advisor is another advisor platform built around what was originally a retail-focused platform. Motif Advisor utilizes “Motifs”, which in practice is just another name for a Portfolio.
Each motif can hold up to 30 stocks and ETF’s.
You can build your own Motif, or select from the tens of thousands that other advisors (and consumers) have created. You can then purchase the Motif in your client account. Advisors commonly have a core Motif, and satellite Motif’s, and use different combinations to accomplish the clients goals.
Motif Advisor allows for two layers of rebalancing – you can rebalance the positions within the Motif itself, or you can rebalance across all the Motifs held in the account.
Motif Advisor allows advisors to ACAT in some holdings (not mutual funds currently) and hold funds outside of the model.
Fees start at 0.25% AUM and go down as the advisors assets grow. They do have a $50,000 account minimum in the form of a $10/month/account fee.
Why would you use one of these, or another, technology-based TAMP? Ultimately it is all about providing your clients with cutting edge technology, and outsourcing work that doesn’t bring clients a lot of tangible value. The new technology-based TAMPs in particular tend to have better client portals, and a more efficient (online-only) onboarding process for new clients and all the associated paperwork (which is handled electronically).
The ultimate goal, with any of the above options, is allowing you to focus on what you love doing, and outsourcing the tasks that you don’t enjoy doing.
Handling Investment Management with a Traditional Custodian
Despite all of the above choices, the most common choice by far amongst advisors is to do the “hands-on” management of investments yourself. By going the “traditional” route, you will sign on with a custodian to hold your client accounts. In practice, the leading custodial platforms can be separated into two groups, as they pertain to new(er) startup advisors:
Type 1: Custodians that primarily work only with large advisors – These bigger custodians typically have advisor minimums such as: Schwab ($25 million), Fidelity ($25 million), TD Ameritrade ($10 million), and Scotttrade Advisor ($7 million). Some will accept advisors below their minimums, but only with a significant platform fee (e.g., $10,000/year).
As a new advisor, these custodians are simply not an option in most cases. In a recent conversation with a sales rep for TD Ameritrade, they admitted that 9 out of 10 advisors that have less than $10 mil AUM fail within a few years.
While I personally think that the lack of support provided by the custodians isn’t helping, it is understandable why they are reluctant to bring on smaller RIA’s.
Type 2: Custodians that specialize in smaller advisors – Two custodians have remained dedicated to newer startup RIAs: Shareholders Service Group (SSG) and TradePMR. Neither of these custodians have minimum advisor assets, and are likely your only choices when starting an RIA.
TradePMR is known for providing additional resources, such as performance reporting and basic rebalancing. SSG is known for really deep discounts to different affiliated service providers they partner with, and for their customer service. In fact, I recently called SSG and the President of the company picked up the phone… hard to beat that!
Many advisors will ultimately decide to establish a relationship with a traditional custodian for a variety of reasons. Some of the more common I have heard are:
Money – Even though the technology-based TAMPs are relatively inexpensive when compared to traditional TAMPs, paying .25% of AUM fees can be a difficult pill to swallow. When you are starting a firm, every dollar counts so it can be tough to pay the fees to their platforms. (Though notably, some advisors simply include the platform fee as a part of their overall AUM fee, effectively passing the cost through to the client, since the all-in expense is still lower than the cost of many mutual funds.)
Control – TAMPs, both technology-based and traditional, force advisors to relinquish some level of control. Whether it is limiting yourself to only ETFs/stocks, or being limited to the investment philosophy of your TAMP, or simply having to rely on someone else to actually make the trades, some financial planners just don’t want to give up control.
Love It – Some advisors simply enjoy providing investment related services and prefer to provide the service to clients themselves.
One of the main reasons that advisors decide to AVOID a traditional custodial relationship is money. Providing investment management can be really expensive, both from a time stand point, but mainly from a hard cost standpoint. Common expenses include:
Custodian – Most custodians require you to keep $1,000+ in your firm’s master account. As a start-up, this is a tough pill to swallow.
Performance reporting software – Providing performance reporting to clients can get really expensive. Orion, a popular choice for performance reporting software, has a minimum annual fee of $10,000/yr. Less expensive alternatives like Blueleaf start at $2,340/yr.
Analytics – Some advisors want analytic software such as Morningstar Advisor Workstation or Riskalyze.
Risk Tolerance Software – Advisors typically purchase Finametrica, or another risk analysis software, to help determine their clients risk tolerance. (Though some may wish to use risk tolerance software even with TAMP solutions.)
Combination Approach
Each group discussed has its pros and cons, but none of the options may be sufficient for your firm. From my experience, when an advisory firm hires a TAMP, they tend to outsource all of their investment-related tasks.
For those choose to work with a technology-based TAMP, many are also establishing a traditional custodial relationship (and splitting clients to each according to client needs and based on client account sizes).
Also, currently none of the technology-based TAMP’s provide “unique account types” like solo 401(k)s, SIMPLE/SEP IRAs, Coverdell ESAs, etc. Most also have limitations on types of assets that can be transferred in, so advisors may need a custodian in addition to help manage these assets in an account if the client doesn’t want to sell the position.
The owner of B+ recently told me that they are seeing a lot of advisors using their platform to manage the core portfolio, and using the custodian to manage other account types, hold legacy assets, invest in “satellite” strategies, etc.
Charging Clients When You Outsource Investment Management
Before we wrap up, I want to address the most common question we hear about outsourcing investment management to either another RIA or TAMP: “How can you charge an additional fee if you outsource all of the work?”
It’s true that by hiring a TAMP you are outsourcing a lot of the work that goes into managing money such as opening accounts, transferring assets, rebalancing, creating/implementing model portfolios, etc. However, I believe that if a computer system can easily do the task, then it isn’t really worth a lot.
Ultimately, the real value that financial planners provide is in helping clients avoid the big mistake. Our friend Carl Richards’ sketch sums it up well:
It doesn’t matter if you help a client beat the market year after year, if during a down market they go to cash. As advisors, we are between clients and their money. We are between clients and doing something really dumb that will ultimately mean they can’t meet their financial goals.
How much is that service worth? In my opinion, a whole lot more than what most advisors charge.
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