The giant raise RIA folk got in 2014 and the threat it poses in 2015

Brooke’s Note: What makes economics such a dismal science but so exciting to write about is that bad is always good and vice-versa. Today’s low wages are tomorrow’s happily cheap labor. Today’s low oil prices are tomorrow’s meltdown of the energy business and also the elimination of a huge damper on consumer spending. Pick your poison. In RIA world, labor costs follow a narrative like health care and college tuition, seemingly locked in a discreet inflation all their own. Advisors benefit — and not. This article fleshes out just how delightful and dismal things are.

The good news is that financial advisors can party like it’s 2007.

Bank account balances of financial advisors, staffers and principals at RIAs are swelling like never before and the end may not be in sight, according to a key industry study showing that non-professionals who don’t directly generate revenue or have primary responsibility for client relationships, i.e. management, support staff and administrative positions, raked in 10% more pay in 2014 than in 2012, and the firm’s professionals, i.e. senior and lead advisors, associate advisors, etc., are realizing two-year raises of 19.9% on average.

Yet such explosive rates of growth are as potentially troubling as they are exciting, according to Dan Inveen, author of FA Insight’s People and Pay Compensation Update for 2014, a survey of over 200 firms tracking RIA compensation trends between 2013 and 2014.

The reason that the rise in compensation is so anxious-making is that labor is far and away the biggest expense item at financial advisory firms. In the days of solo firms, all rising tides were good because managers and owners were one and the same person. But in a time when firms increasingly fit the “ensemble” mode of employing multiple personnel, rising wages can make a firm vulnerable to a serious squeeze on its bottom line. See: How a swath of billion-dollar-plus RIAs are posing a threat to indie advisors.

“At some point, something has to give,” says Inveen, who thinks that “something” will be profit margins. If compensation continues to escalate, profit margins for advising firms will compress over time. This overhead could be especially dangerous for firms when the next down-market comes around and revenues dry up but the pay expectations of advisory personnel remain in the clouds. See: Career Arbitrage: How independent advisors are gaining the upper hand over big corporations in the hiring game.

Failure is an option

It’s not a problem that’s likely to resolve itself anytime soon due to the chronic dearth of next-generation advisors in the pipeline.

“It may not be apparent in an individual basis that the talent problem is acute,” warns Mark Tibergien, chief executive and managing director of Pershing LLC, who has long acted as an industry Cassandra on this issue. “The failure of this profession to actively recruit and develop people is like high blood pressure. It is a silent killer that needs attention.” See: Tibergien uses brutal honesty to captivate big Schwab RIAs and others at San Francisco event.

Inveen, principal and director of research at the Tacoma, Wash.-based consultancy, agrees: “Increasing pay rates are indicative of a persistent shortage of experienced advisors which represent a growing threat to advisory firm profitability.”

50,000 short

Kelli Cruz: I just don’t see
this shortage of talent.

Kelli Cruz, managing director of Mill Valley, Calif.-based Cruz Consulting Group, acknowledges the danger of pay and revenues becoming whipsawed out of equilibrium by volatile markets.

“Owners may take a pay cut, but the last thing to be cut is advisor pay,” she says.

Yet trade research studies and trade media coverage of this situation do not match up with Cruz’s day-to-day observations. The former director of research and consulting for IN Adviser Solutions says that though she’s no longer collecting data, she’s skeptical about the advisor supply gap because these kind of compensation increases haven’t shown up in her consulting work.

“Everybody wants to talk about the quote-unquote shortage of advisors. That’s the story that’s been circulated ad nauseam; but I’m not seeing it in the way the media is writing about it. There is a problem with attracting a younger generation into the industry, but I just don’t see this shortage of talent,” she adds.

But any way you look at it, the problem remains a problem, says Tibergien.

“I have never been to a meeting with advisors where the vast majority have said finding people is easy. In fact, they usually complain that they can’t find or keep qualified people. The age demographics alone indicate a decline in the advisor population, and so too does the absolute decline in the number of people in this business over the past five years (by 50,000 financial professionals). Yet, the number of clients has increased. That’s my definition of a shortage. Consider that only 22% of the profession is under 40 and 5% is under 30. See: The big impression Mark Tibergien and his reverse mentor, Kayla Flaten, 25, made on me over a Manhattan lunch.

In the driver’s seat

Compensation at RIAs for management, support staff and administrative positions has risen about 10% over the past two years, far above the average rise in national wages of 3.7% calculated by the Bureau of Labor Statistics. This in itself is heady enough news to make headlines but there’s even better news: raises for so-called “rainmakers,” senior advisors and associate advisors has far outstripped those gains. In 2013 and 2014, FA Insight found average compensation for these positions jumped 19.9%.

The spike in compensation may reflect an advancement in the industry’s ability to make advisor pay reflect the fortunes of the firm.

“What you could be seeing here is that advisory firms have finally figured out how to align revenue increases with advisory compensation,” Cruz says, suggesting advisor compensation is being boosted primarily due to the 30% gain in the S&P 500 in 2013, and its 11% gain in 2014.

Tibergien agrees. “I don’t see compensation increases by itself as scary. It only is when the economics of individual businesses don’t change. The best performing firms are increasing their fees and achieving greater efficiencies which more than offsets the compensation increases. In addition, the best performing firms are achieving critical mass which means their revenue is growing faster than their expenses. As long as advisory firm owners actively manage to profitability, hold their highly compensated people accountable for results and don’t let fate be their driver, they will be fine,” he writes in an e-mail.

Growth at all levels

But the pay increases may also reflect a defensive posture from RIA principals. The FA Insight study found that the only a third of the professional class of advisors has a 5% ownership stake or more in their firms, implying these major raises were more about retention than profit-sharing.

Still, Inveen thinks there’s probably more good than bad in booming pay. The rise in the securities market is undoubtedly “one of the big reasons behind the increase.” However, he also points to other positive trends for the industry that are helping push up pay. In FA Insight’s consulting work, for example, he has witnessed high client acquisition rates and strong gains in advisor productivity, both good reasons for advisor raises.

Mark Tibergien: The failure of this
profession to actively recruit and develop
people is like high blood pressure.
It is a silent killer that
needs attention.

“Firms are doing a better job managing the capacity of their people, and they haven’t seen the blowout in overhead expenses you’d expect in good years of rapid growth,” he says. See: Buckingham Asset Management creates a structure with Focus Financial that enables it to roll-up the 120 RIAs that entrust it with $13 billion of DFA TAMP assets.

Even if they haven’t seen a blowout in expenses, wealth management firms are still letting their most junior employees share in the success of the booming market. FA Insight found that pay for administrative and support staff showed remarkably strong growth across 2013 and 2014. Even though office managers, receptionists, executive assistants and bookkeepers have analogous duties in other industries and there’s no identified supply crisis for these roles. RIA administrative staffs total compensation still rose 9.2% over two years — a full 5.5% more than the national average for wages.

“From a purely economic standpoint, it doesn’t make a lot of sense,” says Inveen. “I think that these positions are largely benefitting from the good fortune that this industry is experiencing. The pay is probably out of whack with a similar job in another industry.”

Up, up, up

The heartening news on compensation could create a virtuous cycle as regards employment opportunities in the industry. The CFA Institute’s Global Market Sentiment Survey for 2015 reports that 30% of respondents (and 33% of Americans) indicates that they expect employment opportunities to increase in their respective local markets in 2015, up from just 14% who made the same prediction about 2012.

Even though Inveen doesn’t see an end to the stubborn advisor shortage dilemma in the near future, he continues to forecast future wage growth.

“I think we’re going to continue to see pay rising specifically for professional positions. I have to say maybe we’re at the peak of record growth — though I’ve been sounding like a broken record for a number of years,” he says.

Of course, Inveen doubts we’ll continue to see 20% increases in the markets, which he thinks should go at least a little ways toward keeping raises in check.

Cruz, meanwhile, expects advisor pay to largely track the fortunes of the stock market.

The FA Insight study was an online survey of 211 firms, all of which had been in business for over 12 months. Ninety-one percent of responding firms were RIAs or had RIA affiliates; all firms had over $100,000 in annual revenue while 77% had $4 million or less.

The key for advisors today is to take these macro-trends and translate them into their individual strategies for success. It is always dangerous to say: “such trends aren’t relevant to me.” Those are the advisors who are surprised to hear how successful their competitors have become.