The Coming Golden Age Of The (Focused) Solo Financial Advisor

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

For today's Office Hours, I want to talk about a theme that I'm finding is circulating more and more lately, which is the plight of the solo financial advisor and whether ultimately this ongoing wave of both RIA and broker-dealer mergers and acquisitions and industry consolidation will eventually kill the solo financial advisor, as at least some people in the media are now starting to suggest.

In essence, the idea is that the burden of managing a firm, meeting higher fiduciary compliance obligations, handling more complex insurance and investment solutions, doing all the financial planning work, that all of this together is simply going to become unmanageable or at least impossible to do in a cost-effective manner for the typical solo financial advisor in the future, who will then have to either go work at another firm or be acquired and tucked in because you must have size and better economies of scale to be financially viable.

And so I thought today was worth taking a deeper dive into this current state of the solo financial advisor and why I actually think that the next decade is not going to be the death of the solo advisor but actually the golden age for solo financial advisors, with maybe one important caveat that I'll touch on at the end, which I do think is vital for solo advisors to be able to survive and thrive in that future.

The Best Solo Financial Advisors Are The MOST Profitable! [Time - 1:35]

As the starting point, I want to pause and just reflect on... we'll call it the current state of solo financial advisors as they exist today, because this discussion about the death of the solo isn't new. Mark Hurley famously issued a report on industry trends nearly 20 years ago, in 1999, that forecasted the death of the solo financial advisor. And that industry consolidation and a big push for economies of scale would kill off all these small independent advisors. So we can look at industry benchmarking studies today and see whether to what extent this trend is already coming true over the past 20 years.

And what the data reveal is actually really striking. What you see when you look at the industry benchmarking studies is that the best solo financial advisory firms take home as much income as a partner in a $1 billion advisory firm. So let me say that again. The best solo advisors are taking home as much, like, hard dollar cash compensation as the typical partner in a advisory firm managing more than $1 billion of AUM.

Top solo advisors are actually keeping as much as 70 cents, 80 cents, even 90 cents of every dollar of revenue they earn, which basically means in business terms their overhead is as little as 10% to 30% of revenue after all expenses. That's technology, that's office space, that's staff (to the extent that you need any) in just actual dollar terms. What we saw in the last round of industry benchmarking studies is that standout solo advisors are netting almost $600,000 a year in take-home profits on what's about $700,000 or $800,000 of total revenue.

So, to put it mildly, solo advisory firms are not exactly dying in today's marketplace. Now obviously this isn't all firms. This is what most benchmarking studies call the standout category or the top performer category. They kind of by definition carve out a subset of the 25% most profitable or fastest growing firms and then looking at those in particular. So the average solo advisor isn't necessarily this profitable, but the standouts are. And that's based on the top 25% of firms. So we're not talking about just some microcosm of the top 1% of advisory firms that do this exclusive thing.

And these metrics are important because it means that even if the forecasts are right and the costs rise substantially... a large firm sees a 3% increase in overhead, which is actually a big number when you're a large firm, and small firms are inefficient and see a 10% increase in overhead, which is just a monstrous increase... these solo advisors would still be taking home 60 cents, 80 cents on the margin. Which means if they're making $600,000 or $700,000 of gross revenue, they're still going to be netting half a million dollars of cash. Which means, to put it mildly, there's not a lot of danger even if costs get materially higher in the coming years.

I mean, even if you're simply generating $250,000 of revenue, which is frankly more typical for established experienced advisors, and you ran a 60% margin instead of the 80%-plus profit margins of standard firms, you'd still be taking home $150,000 a year, which is still more than 3 times the median household income in the U.S. and is higher than the average salary of an employee advisor. Simply put, there is a lot of room left to succeed as a solo advisor even if costs do rise, as some are predicting.

How Technology Makes It Easier Than Ever To Build A Solo Advisory Firm [Time - 5:10]

Except the reality to me, when you really look at what's happening already in the industry, costs aren't rising to operate an advisory firm, costs are falling. After all just think about what it takes to operate an advisory firm today compared to 20 years ago. So back then, if I had 50-plus clients I was serving in the late '90s and I wanted to meet with all of them, I needed an administrative assistant just to contact them and schedule the meetings. Now I use a scheduling app like Calendly or TimeTrade, 10 bucks a month. In the past, if I wanted to rebalance all of my client portfolios on a regular basis, I needed another staff member just to identify and work up all the trade orders, execute them. If I had tax- sensitive clients I might need another staff member to help do all the client by client tax analytics and details. Now I just buy any number of rebalancing software solutions that implement this at about one-tenth the cost of a staff member.

In the past, in order to do detailed financial planning projections, I needed spreadsheets that had to be manually updated when tax laws changed, that all the client values were typed in manually and had to be updated every time we had a meeting in an incredibly time-consuming, staff labor-intensive process. Now we have robust financial planning software that automatically gets updated from the vendors and account aggregation tools just automate the data update process. So at virtually every possible turn we have, technology tools have replaced what used to be a wide range of administrative staff support that can now do the job faster, more efficiently, and potentially at one-tenth or one-twentieth the cost of what staff members used to be.

We're even seeing this expanded into new categories. Things like what's now being called RegTech, regulation or regulatory technology to support all of our compliance obligations, beginning to grow as a category unto itself with technology platforms like RIA in a Box's ongoing compliance tool, Smart RIA's technology solution for managing compliance. Which again, just continues to hammer down the cost in both dollars and time to manage a solo advisory firm.

I think we actually grossly underestimate today how brutally hard it was to be a solo practitioner in the past. You know, if you go back and listen to some of our Financial Advisor Success podcasts, listen to stories like Deb Wetherby, who today owns a fantastic multibillion-dollar RIA in San Francisco serving affluent clients, when she started 25 years ago, it took her 3 years just to get to break-even and rack up credit card debt affording the basic staff that she needed to support her in the firm because there wasn't much technology. And if you were independent, you didn't get what the mothership provided. Whereas today, you can get a basic RIA business launched for under $10,000 in hard cost in your first year because that's what technology is making possible.

You know, we talk about the risk that robo-advisor technology will replace financial advisors, what I see is robo-advisor technology being used for advisors in what are now being called digital advice platforms, that make it possible to run a solo advisory firm more profitably than ever because the technology isn't replacing us, the technology is replacing all the administrative staff we used to need just to survive, which brings down the cost to execute a solo advisory firm dramatically. And then it's even letting us move down market to less and less affluent clientele because they can be served more efficiently. That's expanding the pie of potential clients to serve. It creates more opportunities for advisors. That's why we see the growth of new business models like the hourly model and the monthly retainer model, and bring into existence entire advisor networks like Garrett Planning Network, ACP, XY Planning Network, that are using their size and bargaining power to further bring down the costs of these hyper-efficient technology tools for solo advisors.

So while 20 to 30 years ago the best technology was all at basically the largest wirehouse firms, because they had the depth of resources to develop it, in today's world, the largest and best resource technology solutions are the ones for independent solo advisors. Because a software company together can serve tens of thousands of advisors at multiple independent broker-dealers and independent RIAs and become larger than any proprietary software solution for advisors ever was.

In other words, the ability to access software of the internet has so turned the tables that now it's the independent advisors right down to the solo advisor who have the most direct access to the largest, most efficient technology solutions we have ever seen in our history. So why would you need to consolidate and try to pursue these ephemeral economies of scale when you already get access to some of the best technology for efficiency that exists today?

The Problem For Solos Isn’t Efficiency, It’s Focus [Time - 9:49]

Now all this being said, I don't want to be insensitive to the plight of many of today's solo advisors today who I realize are not running 80%-plus or even 60%-plus profit margins, who are not taking home half a million dollars in compensation from their firms. Now in some cases, firms are just more limited because they're not serving as affluent of a clientele. You know, most of us top out somewhere between about 75 to 100 clients. So if you work with affluent folks who pay you $8,000 to $10,000 a year, you can generate $800,000 or $1 million of gross revenue and net more than half a million dollars a year. If you work with more middle market folks who maybe pay you just an average of $2,500 a year per client, you'll only gross $250,000 per year. And at 60% to 80% margins, you may only get $150,000 to $200,000 a year net. Now frankly, that's still a pretty amazing number all told, but it isn't quite the eye-popping number of netting half a million dollars a year from your practice as a solo.

But for many advisory firms, the complaint I hear most often is, "The business isn't scaling, and that maybe I need to merge and get more staff and access to more resources so that I can scale it better." Which I find usually is really code for, "This isn't getting any easier as my firm gets bigger. Where are all these efficiencies that were supposed to come along?"

But the real key is that most struggles I see with efficiency that start taking over solo advisory firms, especially once they cross about 50 clients and there's not much free time anymore and all this efficiency stuff really starts to matter, it's a problem because they're trying to do everything for every client they meet. It's a problem because they're still taking every prospect that they meet with. It's a problem because they don't have a consistent solution because they don't have a clear target market, which means they don't have a standardized solution that they can apply process improvement to make it more efficient. In essence, it's a problem of not having focus.

The real issue for most advisory firms that are struggling with all these efficiency issues is not a technology problem... it's not an economies of scale problem... it's not a size problem... it's a focus problem. That's why it takes so long to produce each financial plan because every financial plan is different because every client you serve is different.

Just think for a moment, how much faster it would be to produce your plans if you had a clear niche and all your clients had the same problems and needed the same limited set of solutions. I mean, you'd get to a point where, like, 90% of your financial plan would be a simple template, not because you're not providing customized advice but because your customized advice for your consistent type of client ends up being the same every time when you work with the same type of client every time. You'll be different than everybody else but extremely efficient in your ability to serve the same clients over and over again. Then you don't have to spend as much time researching and looking up how to solve these problems because you've seen it a dozen or 20 or 50 or 100 times before.

Simply put, the fact that so many advisory firms struggle with efficiency isn't because they're small. In fact, growing bigger just makes that problem worse because you just add more inefficient clients and then you add staff and money. You throw that at the problem, which doesn't actually make it more efficient because the clients are still all different and inefficient, and then you just become miserable because now you have to manage more and more staff on top of your inefficient business.

It's a focus problem. Solution here is focusing on a clear or target clientele, transition away or even fire those who are not a good fit, say no to clients who aren't in your focus area, and go deeper with the people you can serve best, not only because it's just good business for the ability to price your services, but because it's so much more efficient when you serve a consistent type of client.

The Marketing Challenge Of Solo Advisory Firms [Time - 13:33]

Now all this being said, I do think there's actually one very real challenge that solo advisory firms do face in the future. It's the marketing challenge of getting new clients and differentiating yourself in the advisory firm landscape for the future. Because there was a time not that long ago where just really truly being a comprehensive financial planner was a sufficient differentiator because there weren't very many of us. Fewer than 1 in 10 advisors had their CFP marks 15 years ago. A lot of advisors just differentiated by literally being the only comprehensive financial planner in their city or their zip code. But those days are over.

There are over 80,000 CFP certificants now. Every major broker-dealer has been making a push into financial planning for years. The RIA community is larger than ever and the firms in the RIA community are larger than ever. It used to be about becoming a $1 billion firm, now it's becoming a $10 billion firm.

If you're a solo advisor, you're not just competing with other solo advisors and salespeople anymore, you're competing with other financial planners. You're competing with the ones at large regional firms. You're competing with a growing crop of national firms. You're competing with other firms getting into our business. You're competing against Schwab and Fidelity branches and their growth of retail CFPs. You're competing with Vanguard Personal Advisor Services, and they're $100 billion of AUM in barely 2 years and hundreds and hundreds of CFP professionals who can serve clients from any zip code.

As a solo financial advisor, yes, you can still go deeper and more customized than these firms. You can have more relevant expertise. You can be more specialized. But unfortunately, few of us are. So many of us in the solo advisor space are still generalist financial planners. And the truth is in the future if someone wants a generalist financial planner, they're going to get it from a larger firm that really will use their economies of scale to price lower than you and frankly will probably flat out out-market you as well. I mean, if you think you can be a better generalist financial planner than Vanguard at 30 bips with a $5 trillion dollar head start on their base of clients, you're fooling yourself.

So there's nothing wrong with being a solo advisor in the future. Technology is making it possible to do it more efficiently and profitably than ever, but there is a problem with trying to out-market a firm that's 100 or 1,000 times your size or even larger when all you're doing is basically the same generalist financial planning advice that they do.

And that's ultimately why I pound the table so hard about why most advisors have to pursue a niche. Because there are almost unlimited number of niches where you can get 50 to 100 great clients, make your mark with specialized services, have a great solo firm, serve them profitably. And then the 100 clients that would give you an amazing lifetime lifestyle practice are just trivially irrelevantly small for a mega national firm like Schwab or Vanguard. They're not coming after your 100-client niche.

But what that means is that the key for solo advisors is basically go niche or go work for someone else. Not because you can't serve clients efficiently as a small solo, but because you won't be able to get clients and differentiate yourself from large generalist firms and out-market national firms if you don't get focused in your practice. It's not actually an efficiency profitability issue, but it's a very, very real marketing and growth challenge. And with the added benefit that getting more focused in your marketing with a niche or specialization will also end out helping you be more efficient as well because the common type of clientele means a common service that you can standardize, make it faster, make it more efficient, reduce the time to produce plans, commands better pricing, power, and all the pluses that go with focus.

But the bottom line, though, is just to recognize that not only is the solo financial advisor not dying, I'd argue there's never been a better time to be a solo advisor, thanks to the rise of the internet and all this amazing technology that allows us to be solo advisors and leverage those tools at just a miniscule fraction of the cost of what traditional staff members required not all that long ago. But the fact that you can be more efficient as a solo won't help in the future if you can't differentiate yourself enough to have any clients sign up in the first place. And you'll lose some or a lot of that potential efficiency if you can't focus your own practice into who you want to serve so that you can use all this technology well to build an efficient solution.

But when you get all that right, we've seen in the benchmarking studies already, those are the advisors who are taking home half a million dollars a year in income. Some of them don't even work full-time and generate that income. Being a solo advisor can be amazing, but you have to bring the focus. And if you yourself are a solo financial advisor who's struggling with profitability and growth and scalability and efficiency, I'd really encourage you to stop and take a look not at the technology you're using and not whether the solo advisor model is broken and not whether you need to tuck in or affiliate with someone else, but whether you are making decisions that limit your own ability to be efficient and focused with the business, and whether just getting more focused rather than growing or merging would help you with the breakthrough you're looking for.

In any event, I hope this is some helpful food for thought. This is Office Hours with Michael Kitces. Normally 1 p.m. East Coast time on Tuesdays but ran a little bit late today due to an earlier client meeting. Thanks for joining us, everyone, and have a great day.

So what do you think? Are we about to enter the golden age of the solo financial advisor? Is the real problem for solo advisors focus rather than efficiency? Is having a niche crucial for solo financial advisors going forward? Please share your thoughts in the comments below!