How should we pay financial advisors to best retain them?
Originally published in CityWire RIA, Angie Herbers addresses how you can retain and motivate advisors, illustrating that compensation is only one piece of the puzzle.
Competitive compensation does indeed matter, but it’s not the only thing that matters. Advisors, like any other employees, want to know their pay is aligned with the value that they bring to the business. Typically, the most widely used formula is a combination of base salary and incentives. But there are hundreds of different combinations of compensation structures that RIAs can deploy depending on their vision and goals.
Unfortunately, too many firms don’t have a concrete vision and/or goals to tie compensation programs back to. As a result, they rely on industry benchmarking data to guide their comp decisions. Doing so provides a simple way to explain to employees how their compensation was decided, but basing pay off benchmarks also makes it easy to ignore the real problem of solidifying a firm-wide vision, a North Star that advisor employees work toward. Which leads to our first point: A clear vision for the firm remains the biggest driver of employee retention.
Firms that don’t have a well-defined vision are susceptible to major flaws in the compensation benchmarks that they rely on, namely the fact that the benchmarks fluctuate based on market cycles. The chart below (Figure 1), which highlights upper-quartile financial advisor compensation, illustrates that financial advisor comp is a moving target.
Herbers & Company, our consulting firm, has tracked upper-quartile financial advisor compensation since 2003. This data was gathered over the years from many industry benchmarking studies on compensation, including our own benchmark studies we have conducted in-house. Looking at the chart, you can see that total compensation tends to rise after bear markets and then decreases during bull markets. (The chart omits several years after 2011 because aggregate comp did not rise or fall significantly during this long bull-market period.)
The compensation pattern is simple to explain. Firm leaders fear losing their advisors in bear markets, and so they increase salaries and incentives for advisors. In bull markets, leaders don't worry as much about losing their advisors because they have deeper profits that can offset potential losses. It’s important to note that pay levels don’t just move in one direction. Unlike many industries, they revert to a long-term average range that doesn’t change much. This owner-favored expense dynamic of rising and falling compensation benchmarks, by the way, is one of the reasons private equity investors love our industry for its benefits in scaling. In other words, advisor compensation does not rise at the rate client fees increase over the same period in the assets under management (AUM) pricing model.
The cycle of rising and falling compensation can make things very messy for firms that use benchmark data to design their compensation packages. If you were to design your employees’ compensation levels at a high point or a low point in the market and compensation cycle, you’d likely be out of step with long-term averages. If you set your compensation based on bear-market data, your employees might be displeased if, in the subsequent bull market, pay rates follow historical precedent and shoot downward. Imagine if you had hired an advisor in 2005 or 2011 and followed the benchmark changes in the chart through the years. Their compensation would have fallen and zigzagged all over the map.
A Better Way to Look at Financial Advisor Compensation
The better way to structure compensation is based on the vision you have for the growth of your firm. The challenge is that every firm’s vision is different. Thus, structuring compensation requires dedication to your firm’s unique needs, goals and vision, not quick benchmarking answers. Compensating your people based on the needs and goals of your business can make them feel like an integral part of the organization rather than an interchangeable cog moving with a data point.
Imagine your advisor employees hearing something like: “We’re giving you a competitive package based on industry averages.” Compare that to an advisor hearing about the direction of the business, the values you represent when working with clients, and the capacity targets and assumptions you use to ensure financial advisors can have a fulfilling life outside of work.
The former merely placates an advisor, while the latter creates an engaged workforce that focuses an employee on the impact they are making. It makes employees feel included and trusted, understood, and valued for their roles and responsibilities within a firm. It sends the message that they are important resources rather than mercenaries of industry data.
That brings me to another point about retention: it isn’t all about money. Based on Herbers & Company’s more than two decades of consulting in the industry, we can say for sure that one of the most effective ways to ensure advisory loyalty is to get them working with clients under a clear vision. Once human attachment happens, the sense of connection and purpose proves to be a powerful factor behind an advisor’s decision to stay or go. But that doesn’t happen if the firm isn’t dedicated to a vision of focusing first on clients.
In my experience, financial advisory firms severely underestimate client connections as a retention tool. They don't understand the extent to which their advisors become attached to clients and the sense of responsibility they develop to help those clients over the long term. Unless they have an entrepreneurial itch, advisors who work directly with clients will often stay with a firm for very long periods simply based on a desire not to leave these relationships. (There is a misconception that most clients will follow an advisor moving from one independent RIA to another, but the transfer success rate is generally less than 20% regardless of the language and restrictive covenants used in an advisor’s employment contract. This low success rate serves as a built-in advisor retention incentive for advisory firms.)
Unfortunately, fear of losing clients can and does influence firms’ decision making around advisor roles and compensation. Firm leaders may experience the departure of one advisor and some of their clients and assume it can happen again. But the fact is that advisors that leave get far more media attention than their numbers warrant.
Parenthetically, handing out raises during bear markets, which helps drive the up-and-down compensation cycle, is not necessary. In down markets, advisors tend to be working hard; they’re focused on protecting and communicating with their clients. Very few are preoccupied with changing firms or starting their own businesses.
The big takeaway here is that when it comes to retaining and motivating advisors, compensation is only one piece of the puzzle. The best results occur when firm leaders take the time to understand their business, know where they want to take it, and have a clear plan for getting there. When that’s the case, how and how much to pay your people naturally comes into focus.
