Last fall, a series of statistics were published regarding organic growth in the registered investment advisor (RIA) industry, making clear what many people have whispered for years: Organic growth among RIAs is anemic. Fidelity published a report showing that larger firms had 3.6% organic growth in 2023, while smaller ones experienced even less at 3.2%.
Further, at his fall Tiburon Research conference last year, CEO Chip Roame shared research indicating that the figure was even worse, with net flows of just 2.4%. Roame wondered aloud from the stage whether, with inflation being what it is, we can even call this business a growth industry. While ~3% growth isn’t zero, we likely wouldn’t put our clients in stocks growing at those rates unless they were paying dividends. But then again, we wouldn’t call those stocks growth investments, right? Roame also stated that 77% of all RIA flows go to the top 6% of firms, meaning that the median RIA is actually shrinking, not growing.
What is organic growth anyway?
Simply put, organic growth is the measure of how much a practice grows or shrinks independent of market performance. If we’re measuring growth in assets under management (AUM), organic growth would refer to new assets from existing and new clients, minus withdrawals and terminations. To paint a simple picture, if an RIA started the year with $200m in AUM, it could look like this over one year:
AUM Growth table from Gary Roth
What’s going on here? With all the news about assets and clients flowing to the RIA model, why do we not see ‘same store’ sales at much higher levels? I’d posit that the issue isn’t that advisors don’t know how to grow organically, but rather that many just don’t particularly care to do so.
For anyone who has looked at RIA acquisitions and the underlying growth metrics of target firms, the lack of true organic growth is no surprise. I’ve looked under the hood of hundreds of advisory firms over the last 20 years and can tell you that most firms do not even track organic growth unless/until they hire an investment banker to market their firm for sale or investment. Frankly, even though they should care very much about it, most advisors don’t worry about organic growth. In my experience, here are a few reasons why.
You only need to be flat to maintain your current income
In the old commission-based world — and in bonus-based jobs such as investment banking and other corporate roles — some or all of your compensation resets at the beginning of each year. You either have to produce new business or hit key performance goals to make the same or better compensation as the year before. But in the fee-based advisory world, if you’re happy with what you make, all you need to do is tread water to keep your income where it is. If you have 2-3% distributions and 1-2% percent terminations, you need just 3-5% growth (plus or minus expense increases) to maintain your income. That’s not too far from the growth rates reported for the industry as a whole.
Now, there are generally three phases to the lifecycle of an advisor’s book of business: building a book, maintaining the book and cruising towards retirement or a sale. With the average age of financial advisors hovering around 56, most advisors are in the ‘maintaining’ phase. In other words, they did the hard work of building a client base over the past 10-20 years and are now reaping the rewards of a solid practice. As long as they maintain a rough equilibrium, bringing in enough to replace what they lose, their lifestyle stays the same. Sure, they may need to add staff, and costs may go up, but that leads to a question: Do I want to invest to grow? Or do I just put revenue increases towards maintaining my current base?
Growth costs money…
One sure way to make less money in the short run as a business owner is to spend more money. If I decide to invest in growth — and growth does require investment — then out of the gate I make less. Hiring a public relations or marketing firm, launching a podcast or even redesigning a website requires real out of pocket expenses, often tens if not hundreds of thousands of dollars. As a result, the typical firm, per Michael Kitces, only invests 2% of its revenue towards growth. Incidentally, that’s just enough to offset the natural decline from withdrawals, terminations and clients passing on. Plus, onboarding new clients requires a lot more work than ongoing service, so that means finding and attracting new advisors requires an investment in time and funds, not to mention that talent is hard to find.
…Except when it’s free
Why would an advisor make this investment when they can get their growth for free (albeit not organically)? We’ve experienced a bull market (more or less) since the global financial crisis of 2008. Since then, the average return of the S&P 500 has been 13.8% a year, or 11.2% adjusted for inflation. If you take the latter figure, assume a traditional 60/40 investment allocation, and just for illustration purposes assume no return from the bond portion of the portfolio, you still get an average gain of over 6.5% for the past 15 years. Any advisor who has been in business over this period has seen growth more than double during that time, which feels pretty good! The question these advisors don’t necessarily ask themselves is: What would my business and life look like if the free lunch goes away?
This effect, I believe, is why most firms I’ve met with over the years do not bother measuring organic growth — they just measure growth overall. You have to really dig in to understand whether they are actually getting any new clients or new assets or just riding the bull market wave.
While many advisors are comfortable with their earnings and don’t see a reason to invest towards growth, there are myriad reasons why they should care. We’ll delve into those in the next article in this series.
Gary Roth is the co-founder and co-CEO of Modern Wealth Management, a private equity-backed RIA with about $3.7bn in client assets under management. Roth previously worked in various C-level executive roles at $25bn serial RIA acquirer United Capital Financial Advisers. After United Capital sold to Goldman Sachs in 2019, he became a managing director at the rebranded Goldman Sachs Personal Financial Management entity.
https://citywire.com/ria/news/opinion-the-dirty-little-secret-about-ria-organic-growth/a2443471
