Understanding the hidden economics of independence: How smaller can be more cost-efficient than bigger

Regardless of what they wind up doing, most experienced advisors who are employees of broker-dealers have thought about going independent. If that thought ever went beyond an idle daydream, such advisors did some groundwork and acquired a good understanding of the basic economics of independence: the advisor gets a much bigger payout in exchange for assuming more of the expenses of running his or her own business.

While that basic premise is certainly true, there are nuances of “independence economics” that are critically important to advisors, yet which many haven’t had a chance to learn. We call these the hidden economics of independence, and they are worth examining for anyone considering their next professional steps.

The key lies in analyzing an advisor’s costs in the independent model.

When many advisors who consider independence look at the payout/cost trade off, their thinking goes something like this:

“Yes, I’ll get more of what I produce, but I’ll have to hire and pay employees, find an office and pay rent, research and buy or lease office equipment and probably run into a lot more obstacles that I don’t know anything about and which will be expensive. In the end, I’ll probably take home not much more than I do now, or maybe the same thing, so why go through the hassle and the headache?”

If the economics of independence were only about immediate income, that line of thinking occasionally has a measure of validity, although employee advisors typically are misinformed about costs. Aside from business expenses in an independent setting, the components of independence advisors typically don’t see are the potential tax benefits of independence, the ability to amass long-term wealth and — for what many becomes just as significant as compensation and sometimes even more important — the opportunity to run a business that provides the satisfaction many advisors feel has been bureaucratized out of the business.

In this column we’ll explore the cost issue more closely. So let’s start with the bottom line: Costs are likely to be less than you imagine – and you have the ability to control many of these costs.

The chart below is a breakdown of the average overhead expenses of an independent firm, according to the 2015 InvestmentNews Adviser Compensation & Staffing Study. (Note, overhead expenses only include administrative and operational costs and does not include direct expenses, which are largely the advisers who lead and run the business.)

Support staff, such as office managers and client services associates, typically comprise half of your overhead costs as an independent adviser. In the independent world, you govern your decisions around how many support positions you need – and ultimately how much you allocate to these positions. In many cases, while these positions are viewed as overhead, they should be considered investments because they can have a direct return on your ability to be productive, handle more client relationships, and bring in new business for your firm. So while it is often the largest expense, it is up to you how much you want to invest in support personnel – and how you want to leverage these positions to grow your business.
While office rents vary around the country, most advisers find that they can occupy very attractive space that suits their clientele at much less cost than the occupancy expense allocated to them as an employee. In fact the flexibility afforded by independence means they can locate their office closer to their clients or to space that is more convenient than the offices of larger firms.

Outfitting offices is now much less expensive as well, with many companies offering favorable leasing and installment payment options. Technology costs also have come down significantly. Many independent representatives find that their new technological tools are equivalent to or even more advanced than the ones they left behind, and that support is better and costs lower than they anticipated.

Personnel is another area where advisers may be pleasantly surprised — not only by the caliber of people they can afford to hire on their budget, but by having the flexibility to define jobs functions and requirements in ways that result in greater efficiency and productivity. Many advisers who have chosen independence find that their staff is so much more productive that paying them more is actually economical.

Along with occupancy, technology and personnel costs that employee advisers bear indirectly, a key cost that becomes apparent once an adviser becomes independent is the cost of managing a large retail brokerage firm with thousands of advisers. An independent adviser does not have carry the proportional overhead cost of maintaining a branch system. While independent advisers must bear the costs of compliance — which in the independent environment is just as rigorous as it is in the employee world — the absence of layers of non-compliance related personnel frees funds for great payouts.

The absence of bureaucracy in the independent world, plus the cost savings that typically occur when an adviser/entrepreneur makes the purchasing decisions, makes independence a more efficient and profitable operating environment. And as we’ll see in subsequent columns that examine its hidden economics, independence also can provide levels of long-term wealth and day-to-day professional satisfaction that advisers may not have considered.

For more detail, download Wells Fargo Advisors Financial Network (FiNet) white paper, “Independence Simplified.”