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November 17, 2003 at 07:00 PM
This month’s issue of Practice Edge is the last of a three-part series that closely examines the best practices of RIA firms as revealed through AdvisorBenchmarking.com’s latest survey of 655 RIA firms. Based on the Top Firms benchmark–a composite made up of 23 firms that have met our stringent performance criteria–we compare the most successful RIA firms to the rest of the marketplace. These top firms manage assets of $330 million on median, compared to $71 million by the average RIA firm.
In this issue, we examine the best practices in the area of financial management, highlighting the success factors pertaining to effective profit management. Specifically, we take a look at three key areas: profitability focus, revenue sources, and economies of scale.
Profitability Focus
Most RIA firms tend to measure success based on their assets under management (AUM). And rightly so: last year the average firm generated 75% of its revenue from AUM fees. However, advisors often downplay the importance of profitability to their business while overemphasizing the impact of AUM on their financial health. It’s not uncommon to see one firm with three times the assets of another, but half the profitability.
Top firms, on the other hand, place more emphasis on profits and margins relative to assets. In fact, when asked to rate the “top business goals” for their firms on a scale of 1-10, top firms rated “increase profits” at 9.5, compared to only 8.8 by the average firm. Conversely, top firms gave a lower rating to “increase assets under management” at 8.5, while the average firm gave it a higher rating of 9.2. This heightened focus on profitability is one of many differentiators that set apart the top firms from the rest of the marketplace. Possibly as a result of that increased focus, top firms have net profit margins of 29.03%, compared to only 24.5% for the average firm.
Revenue Sources
As we had reported in AdvisorBenchmarking’s latest research study, RIAs across the board have increased their use of financial planning fees. Last year, RIA firms generated 23.4% of their revenues from financial planning/consulting fees, up substantially from 11.5% in 2000. One of the many forms of such fees is retainers–the advanced payment the client makes at the outset of the relationship.
Examining the revenue sources of top firms, we find that 100% of them charge retainer fees to some or all of their clients, compared to only 31% of the rest of the RIA firms. Needless to say, charging retainers is usually commensurate with the breadth of services the firm offers. Wealth management firms that offer a broad spectrum of services often find it easier to charge such advanced fees. Since a broad “range of services” was one of the criteria to qualify for the top firms’ composite, it is not surprising that all the top firms charge retainers. But the takeaway here for advisors is that charging retainers is one way you can diversify your revenues. Retainers do not just provide you with an additional source of revenues, they also provide you with a source of revenue that is not dependent on the assets you manage. This lack of correlation to AUM fees makes for a good revenue-hedging strategy when your assets and the stock market are falling.
