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Is Sales or Better Client Retention the Best Way to Grow an RIA Firm?

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Written by: RIA in a Box

If a small business seeks to grow, traditional business wisdom is quite simple: devote more resources to sales and marketing efforts in order to win more new clients. Registered investment adviser (RIA) industry experts generally advocate a similar approach if an advisory firm wishes to accelerates its growth. While it is true that bringing on new clients will generally lead to asset and revenue growth, a deeper dive into the unique characteristics of the investment adviser industry raises the question as to whether more firm resources should instead be allocated to increasing client engagement and retention.

The RIA Industry’s AUM Pricing Model is the Envy of Other Industries and for Good Reason

One of the most unique characteristics of the RIA industry compared to most other traditional industries is the assets under management (AUM) pricing model. While there is renewed debate around whether the AUM pricing model will one day be complemented by or ultimately replaced by a flat-fee or retainer-type pricing model, the industry today still almost entirely charges on an AUM-based fee model. Very few industries have the luxury of an established pricing model which has a built-in price escalator as the value of the client’s portfolio, while often volatile, generally rises over time. Vanguard notes that a traditional moderate portfolio (50% stocks and 50% bonds) has an average annual return of 8.4% from 1926-2014.

Assuming the advisory firm charges an average advisory fee of 1% per year and using Vanguard’s average portfolio returns, a new client who hires an RIA firm with a beginning moderate risk portfolio value of $1,000,000 would generate around $10,000 in year one client fee revenue. However, by year 10, assuming an 8.4% annual return that client’s portfolio value would now total approximately $1,901,000 after advisory fees equating to $19,000 in annual fee revenue from that client. Of course, this basic math while not perfectly scientific, is well understood in the industry. Yet it seems that the investment adviser industry at times does not fully appreciate how lucrative of a pricing model it possesses. 

In the above client scenario, the cumulative client fee revenue over the ten year period is just under $141k. On other hand, a fixed $10k per year price would have generated $100k in cumulative revenue over that same ten year period. Thus, in this scenario, the escalating effect of the AUM pricing model led to a nearly 41% increase in total cumulative revenue. Now instead let’s assume the client continues to remain an advisory client for twenty years with the firm. Over this longer period, the leverage of the AUM pricing model becomes even more pronounced. In such a scenario, the cumulative client fee revenue over the twenty year period is just over $428k compared to $200k in cumulative revenue over the same time period under a fixed $10k per year fee. As such, the escalating effect over 20 years now leads to a 114% increase in total cumulative revenue. 

While long-term client retention is generally a powerful growth tool for a business in any industry, it’s an even more powerful growth accelerator in the investment adviser industry given its pricing model leverage. The above scenario also illustrates the compelling economics in increasing the average client relationship life. If the above client leaves the firm after 10 years, the firm is losing out on nearly $288k of future incremental revenue that can be earned in years 11-20. 

The RIA Client Referral Growth Multiplier Effect

Often, traditional “How to Grow Your RIA Firm” wisdom focuses on new client business development. These may include hosting local seminars, advertising in local publications, sponsoring local events, and strengthening relationships with local centers of influence (accountants, estate planning attorneys, etc.). While such strategies can be very successful with proper dedication and firm focus, not all principals of advisory firms have the budget or natural comfort to pursue such initiatives.

The good news for such firms that have a desire to grow but inability to implements the above business development tactics, is that it may be easier for an RIA firm to grow faster and larger by instead focusing on existing client retention rather than on new client business development.  

To make our case, we first need to make some basic assumptions and dive into some more analysis. First, let’s make the following sample advisory firm assumptions:

  • Total Clients: 50
  • Average Beginning Client Portfolio Size: $1,000,000
  • Average Annual Advisory Fee Charged: 1.0%
  • Average Annual Client Portfolio Return: 5.0%
     

So, here we have a classic advisory firm with $50 million in AUM serving 50 clients with average annual portfolio growth slightly below Vanguard’s moderate portfolio estimates. Let’s now next assume the following client growth, referral, and retention metrics:

  • New Non-Client Referral Clients Added Per Year: 3
  • Annual Client Retention: 90%
  • Client Referral Rate: 5%
     

Thus, we are assuming this firm brings on 3 new clients every year which are not referred by an existing client. There are various figures on industry client retention but most studies put the annual client retention rate in the 80-100% range depending on client age, length of relationship, etc. In addition, we are assuming that 5% of the firm’s clients will refer a new client with the same characteristics to the firm on annual basis. In other words, on average a client refers one client to the firm over 20 years.

With the assumptions above, the sample $50 million AUM advisory firm will conclude year 10 with around $74.36 million in assets (48.7% in total cumulative asset growth) and $6.38 million in cumulative revenue. This is detailed below:

RIA Firm Focusing on New Client Business Development

Now instead let’s assume the same $50 million AUM firm shifts resource focus away from bringing on new non-client referral clients and instead focuses on driving client engagement and satisfaction ultimately leading to higher annual client retention. In this modified scenario, we change only two assumptions:

  • New Non-Client Referral Clients Added Per Year: 0
  • Annual Client Retention: 95%
     

With the modified assumptions above, the same $50 million AUM advisory firm will conclude year 10 with around $74.40 million in assets (48.8% in total cumulative asset growth) and $6.29 million in cumulative revenue. This is detailed below:

RIA Firm Prioritizing Client Retention to Grow

The results in both of the above scenarios are eerily similar despite the fact that in the second scenario, the firm is putting no resources towards winning non-referral clients and instead prioritizing increased client retention. 

Now, let’s look at a third scenario in which the same $50 million AUM advisory firm prioritizes not only increased client retention, but also on internal focus to increase existing client referrals from 5% to 10% of clients in a given year making referrals. Thus, the assumptions are:

  • New Non-Client Referral Clients Added Per Year: 0
  • Annual Client Retention: 95%
  • Client Referral Rate: 10%
     

With these last modified assumptions above, the same $50 million AUM advisory firm will conclude year 10 with around $118.47 million in assets (136.9% in total cumulative asset growth) and $8.32 million in cumulative revenue. This is detailed below:

RIA Firm Increasing Client Referrals

By moving the client referral rate from 5% to 10%, the same firm was able to increase year 10 total assets by close to $44 million and cumulative ten year revenue by over $2.5 million. Now imagine what may be achievable if the firm was able to move the annual referral rate to 20% (each client making a client referral once every five years), the RIA client growth multiplier effect is a tremendous growth lever for advisory firms.

Couldn’t the same results be achieved through new client business development?

A fair question in relation to the above scenarios is couldn’t this same growth be achieved by instead focusing on new client growth? The answer is yes. However, it may not be as easy to replicate those same results as it seems.

To quantify this a bit, let’s again revisit that same $50 million AUM investment advisory firm used in the previous examples. It turns out that if the firm instead focused on new client growth instead of on improving client retention and referral rates, the advisory firm would need to win around 7.6 new client relationships each year in order to achieve similar results as seen the final scenario above. This is detailed below:

RIA AUM Growth by Adding New Clients

Bringing on close to 8 new non-client referral clients a year to sub-$100 million AUM RIA firm is possible, but in our observations, it’s generally the exception rather than the norm. Bringing on such clients requires dedication, and unfortunately at times that new client business development focus can come at the expense of the existing client experience. Every growing investment advisory firm faces the constant tug and pull between bringing on new clients or spending more time and resources on existing clients.

In addition to this internal resource struggle, new client acquisition often has a significant financial cost to the firm. Hiring and compliance supervision of a business development-focused investment adviser representative (IAR), a long multi-year sales cycle, dinners, and other marketing costs, are all factors that can contribute to a significant client acquisition cost (CAC) for RIA firms. As such, the case for focusing resources on existing clients can at times be an even more compelling argument when the CAC of a new advisory client and front-loaded client service and portfolio management work needed to bring on a new client is fully factored into the lifetime value of the client. Many investment advisory firms need the client to stick around for a few years before the firm fully recovers its acquisition cost of winning that new client and the client becomes profitable. 

Initially, most principals of emerging, state-registered RIA firms have ambitions to bring on new clients while never losing a desirable existing client. Ultimately, many firms are forced to make a decision as to where to focus limited resources. Traditionally, the principal has decided to pursue the new business development route as that is what intuitively seems to make the most sense: to grow, I need to go out and bring in new clients to the firm. For new firms entering the investment adviser industry, that decision is often not much of a decision as the firm desperately needs to clients in order to start building a business. However, once a firm reaches a critical mass of clients, it may make sense for the principal of the firm to take a step back and start thinking more about optimizing the existing client experience rather than focusing on bringing on more clients. 

Hire a new Director of Business Development or Client Success?

While there are likely a handful of progressive and large RIA firms that have a Director of Client Success or similar role at the firm, this is far from a traditional role at an advisory firm. Instead, firms looking to grow tend to devote more resources towards sales and marketing often by hiring or recruiting a new advisor that will be focused on generating new client relationships. Again, such a strategy matches traditional wisdom and there is nothing inherently wrong with that wisdom. 

However, the Director of Client Success role is a new emerging position that has gained initial traction in the software as a service (SaaS) industry. In a nutshell, this role is focused on improving client engagement by optimizing the client experience ultimately leading to longer client retention and when optimized, more client referrals. While the investment adviser industry is quite different from the software space, it does share a common theme in that in both industries, much of the long term profitability of the client is dependent on client being retained for many years given the significant upfront acquisition and client on-boarding costs. As such, it may be time for the RIA industry to start considering its own version of the Direct of Client Success position.

Many RIA firms looking to accelerate growth will often consider our Rushmore Advisor Services practice management platform if they are looking to utilize a single platform that already includes many of an investment advisory firm’s key technology requirements. The platform includes a number of features designed to increase client engagement and retention including portfolio management and reporting, automated billing, automated account aggregation, a client portal, a robust customer relationship management (CRM) system, and document storage. The price begins at $375 per month per advisor and also includes access to MyRIAComplianceTM, an online RIA compliance software solution.

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