STEPPING STONES TO AN ADVISORY TRANSITION

STEPPING STONES TO AN ADVISORY TRANSITION INSIDE: Many advisors are moving toward advisory models when appropriate for their clients and their practice. Here s why you may want to follow suit and how you can transition to an advisory model successfully. THE CASE FOR ADVISORY A notable shift is underway in the financial services industry. Advisors are increasingly considering a move from brokerage to advisory business, when appropriate for their clients. In a recent survey by LPL Financial and WealthManagement.com, 1 more than half of the respondents said they have transitioned their business to an advisory model within the past five years. One factor that might continue to drive, and even hasten, the migration toward the advisory model are regulatory trends. Operating in an advisory capacity already carries with it a fiduciary responsibility to clients, and moving to the advisory model may help advisors better align their processes with all regulatory requirements. In addition to compliance, advisors who have made the switch said they did so for several key reasons, including improved flexibility in managing clients assets, the ability to offer a broader menu of services to address clients needs, and the freedom to provide clients with more objective advice that ultimately can help foster stronger relationships. What s more, an advisory model provides clients ongoing service from their advisors for a regular ongoing fee. Many advisors come back to me and say, This wasn t nearly as challenging as I thought in fact, I wish I had done it earlier. Verne Marble, senior vice president at LPL, on the realities of transitioning to an advisory model Even after knowing all the potential benefits of transitioning to an advisory model, many surveyed advisors said they are still hesitant. They have concerns ranging from segmenting their book of business to establishing fees for services about the difficulty of transitioning. While these concerns are valid, they aren t insurmountable: Steve LaChance and Verne Marble, both senior vice presidents of Investment &

Planning Solutions at LPL, have worked with scores of advisors, guiding them through their transition to advisory practices. Their advice: Advisors can approach and overcome those challenges in a number of ways, potentially positioning themselves to improve both their client relationships and the value of their business. And with the shifting regulatory environment, confronting those challenges and making that shift in business model may be more important than ever. POTENTIAL BENEFITS OF THE ADVISORY MODEL The advisory model, and the focus placed on service over sales, can benefit both clients and their advisors. Here are three key potential benefits of transitioning to an advisory model: 1. Build stronger client relationships Using an advisory model, advisors are free from the obligation to sell investment products and can focus fully on providing clients with objective investment advice. Therefore, an advisory model can help to strengthen the client-advisor relationship. An ongoing relationship, versus a transaction-based relationship, not only helps clients manage the frequently emotional demands of investing, but also helps them feel more comfortable sharing their needs and goals, which are critical to financial planning. Clients say they want this kind of contact and service from their advisor, Marble said. A 2015 Gallup poll showed that 70% of people considered a strong relationship with their financial advisor to be either somewhat or very important. 2 It s evident that a view toward establishing ongoing relationships with clients in an advisory model can result in attracting new prospects. Marble said, Those advisors who don t adapt could run the risk of having new prospects or clients being poached by other advisors who do. 70 % Percentage of people that consider a strong relationship with their financial advisor to be either somewhat or very important. 2 Meanwhile, an advisory-based arrangement appeals to many advisors: According to the LPL and WealthManagement.com survey, 44% of advisors said they believe that making a transition to an advisory-based business would allow them to deliver better service to their clients. 2. Charge consistent fees In the advisory model, advisors generally charge a percentage of their clients assets under management. They might also use fixed or flat fees, hourly rates, annual retainers, or a combination of rates and fees for different services. As long as clients stay with the advisor, those fees are ongoing. Keep in mind, a shift to advisory requires an increased level of care and increased responsibilities to your clients. In the advisory space, you are acting as a fiduciary and you re responsible for putting the clients interests first in all matters and avoiding conflicts of interest at all costs. This is in contrast to participating in brokerage business, where you re held to the suitability standard, which means you must know your clients and their financial situations and recommend products that are suitable for their situations today. The potential to charge consistent fees, when it s appropriate for their clients, has LPL FINANCIAL 2

many advisors considering the move to an advisory model. According to the LPL and WealthManagement.com survey, more than half (51%) of advisors income today is advisory, and advisors said they expect advisory revenues to grow to 62% of total revenues over the next five years and commissions to fall to just 35% of overall revenues (the 3% remaining is salary). That shift is expected to be more pronounced in certain segments of the advisory industry. For instance, wirehouse advisors who participated in the LPL and WealthManagement.com survey generate an average of 40% of their income through fees today. However, in five years, wirehouse advisors expectations for advisory income are nearly identical to other firm types, signaling a strategic focus for these advisors. Advisors are getting to a breaking point, said LaChance, senior vice president of regional consulting at LPL. They want a more consistent business process that the ongoing relationships in advisory can offer. Income Sources Currently, respondents incomes are derived mostly from fees and commissions. Independent RIA firms with no broker/dealer affiliation currently have the largest percentage of fee business, while insurance firms have the most commission business. A movement to fee business is expected over the next five years across all channels. What percentage of your income is from each of the following? Five years from now, how do you anticipate your income distribution to look? Fees Commissions Salary Fees Commissions Salary All Respondents 51% 44% 4% All Respondents 62% 35% 4% Independent RIA firm, no broker/dealer 92% 6% 2% Independent RIA firm, no broker/dealer 91% 5% 4% Independent RIA firm, also affiliated with a broker/dealer 54% 44% 2% Independent RIA firm, also affiliated with a broker/dealer 72% 26% 1% Independent broker/dealer 43% 54% 3% Independent broker/dealer 55% 43% 3% Wirehouse 40% 54% 6% Wirehouse 61% 37% 2% Base: All respondents (N=291 for both charts) Note: Percentages may not total 100 due to rounding. Source: Penton Wealth Management, Industry Trends Study, Page 11 LPL FINANCIAL 3

3. Grow the practice Another potential benefit of an advisory practice is it tends to attract high-net-worth clients who want comprehensive planning services. As a result, an advisory model may be an appealing option for advisors hoping to move upmarket and grow their practices. Working on commission makes it far more difficult to scale your business, LaChance said. If advisors want to evolve their practices and attract those bigger clients, they need to consider changing to a model that allows them to provide those [expected] services. Most advisors have considered it. According to the LPL and WealthManagement.com survey, 42% of advisors said they see switching to advisory as an opportunity to attract larger clients and increase business. Changing models is an important consideration for the difference it could make for the business not just today, but at the sale of the practice. Going to an advisory model may result in a higher valuation multiple for the practice, helping the advisor receive a larger payment when it comes time to sell. One PriceMetrix study indicates more than double business valuation per dollar in recurring revenue. 3 OVERCOMING THE CHALLENGES Despite the potential benefits of adopting an advisory model, many advisors still express concerns about making the move. Before transitioning, advisors must assess their practice and think about their services and what they re worth in a way they may never have before. Prepare Talking Points When introducing the advisory model to clients, it might be helpful for advisors to prepare talking points on the following potential benefits: Enhanced service model Better alignment of interests between client and advisor More flexibility Greater standard of care More investment options The LPL and WealthManagement.com survey found a number of major sticking points for advisors considering a move to an advisory model. In almost all cases, there are steps an advisor can follow and resources to take advantage of for a successful transition. 1. Challenge: How do I explain the value of an advisory approach? Many respondents to the LPL and WealthManagement.com survey cited resistance from clients to any proposed change in investment platforms. For advisors who have worked in a brokerage and transactions-based model for their entire career, being asked to justify expenses and new fees can be challenging. That s why it s so critical for advisors looking to make the shift to an advisory model to define their value proposition, to determine who they are as a firm, and to fully understand how their work may benefit the lives of their clients. Solution: Develop Your Value Proposition The value proposition is a key piece of the explanation process. An advisory firm s value proposition identifies the full range of services and support the practice delivers, and how those services may benefit its clients. Advisors who are concerned about resistance from clients likely need to clarify the value their services provide, Marble said. LPL FINANCIAL 4

Clients who attach value solely to investment performance are likely following the lead of their advisor, he said. As a result, advisors may need to educate clients on the value of ongoing financial advice and services that help meet their financial needs and goals. In addition to defining a firm s unique approach to problem-solving, a firm s value proposition should include information about its commitment to accountability and fiduciary responsibility, if it applies. Advisors who articulate their value, and who have confidence that the transition will truly help them serve their clients better, tend to have a positive experience with the conversion process. The LPL and WealthManagement.com survey found that for 75% of advisors, the transition to an advisory model occurred without obstacles, including sticking points over new fees. The fee ends up being a nonissue for clients who are convinced that the transition is in their best interests, Marble said. Being able to break down the potential benefits can help clients take stock of each and appreciate the impact the overall transition could have on their financial lives and on the level of trust they have in their advisor. 2. Challenge: How do I price my services? Another major concern advisors expressed in the LPL and WealthManagement.com survey was uncertainty over how to price their services as an advisory professional. The process seems far scarier or more daunting than it really is, LaChance said. Solution: Use an Existing Model When it comes to developing a pricing model, advisors don t need to reinvent the wheel. Many resources are available to help advisors understand market prices and set their own reasonable and fair prices, from third-party research by the likes of PriceMetrix and Cerulli to the experience of other advisors who have made the transition. It is also important to review any pricing restrictions for any advisory programs that you intend to use with your clients. Categorize Services Advisors can organize services and activities into corresponding categories that might include: Investment management Asset allocation and portfolio construction Due diligence on fund managers and strategies Trading and rebalancing Client service Account reviews Client meetings Market updates Complementary services Insurance College planning Estate planning and philanthropy Tax management Home, car, or business purchase assistance Advisors can use the transparency of the fee model to their advantage. Showing clients exactly what services they re paying for not only reinforces the advisor s value proposition, but invites the kinds of questions and conversation that inspire trust. LaChance contends that advisors can think of the pricing process as an opportunity, as opposed to an onerous task. 3. Challenge: How do I segment my clients? Many survey respondents expressed concerns about segmenting clients by asset level and providing different levels of service for each level. In particular, they worried that this kind of tiered structure might limit the clients they could work with, potentially shrinking their client base. LPL FINANCIAL 5

Such concerns are understandable, but misguided. Segmenting makes a practice more efficient by allowing advisors to formulate and deliver strategies that are tailored to each client. Solution: Consider Your Clients Advisors may have clients with lower levels of assets who might need more basic financial planning help retirement and college savings, household budgeting and less customized investment management strategies. Wealthier clients, on the other hand, might require sophisticated portfolio and estate planning tools that take more time and effort to manage. The most important consideration when reviewing your clients is what is appropriate for their investment needs. Once that review has been done and it has been determined which clients are appropriate to be moved into advisory, advisors can determine if further segmentation is appropriate. 75 % Percentage of advisors who transitioned to an advisory model without obstacles. 1 For example, creating different levels of service based on client needs can ensure advisors allocate their time and resources appropriately. Advisors are required to provide all advisory clients with ongoing advice, but the frequency of that advice may depend on the sophistication and needs of the client. Another option is to provide service from advisors at different levels of experience. A senior advisor might handle the practice s first-tier accounts whose needs might be more complex while less-experienced advisors work with clients in the lower tiers whose needs might be more basic. Segmenting may also require the introduction of account minimums. Some clients who are currently part of a firm s book of business may not have the assets necessary to meet the new minimums. Account minimums may also be a helpful tool in determining when advisory is appropriate for a client as opposed to remaining in a brokerage relationship. In cases where a brokerage relationship remains most appropriate, firms can work with their broker/dealer to keep those clients in brokerage relationships or consider using a technology-driven advisory solution. 4. Challenge: Will a transition to advisory disrupt my business? Many advisors who are interested in making the jump to advisory are concerned about disruption to the business during the transition. That s valid, Marble says. The solution, he explains, is to manage the transition in stages not all at once. Solution: Develop a Transition Strategy Advisors can start by reviewing their existing book of business and identifying clients who are appropriate for advisory offerings. Those clients with whom they have long relationships and a lot of trust may be good candidates for the first wave of a transition. LPL FINANCIAL 6

SEIZING THE OPPORTUNITY Advisors have understandable reservations about transitioning to an advisory model. Nevertheless, it represents a tremendous opportunity, when it s in the best interest of their clients and practice, for advisors to increase the level of service they offer clients and grow their business. Advisors are like everyone else: They fear the unknown, LaChance said. Getting all their ducks in a row can go a long way toward tempering that fear. Advisors may be able to navigate the process more smoothly if they understand their value proposition, use it to develop price and segmentation models, and create a plan to stage the move over time. Many advisors come back to me and say, This wasn t nearly as challenging as I thought in fact, I wish I had done it earlier, Marble said. PREPARING FOR YOUR TRANSITION TO AN ADVISORY PRACTICE Once you re licensed and registered as a registered investment advisor (RIA) or investment advisor representative (IAR), follow this checklist to help facilitate the move: Evaluate your broker/dealer support for advisory platforms. Determine your new value proposition and why you re moving to fees. Choose the clients you want to convert. Establish financial targets. Select the investments you want to use. Price services and set fees. Build a conversion schedule for your practice. LPL Financial s Advisory Platform Support By providing a broad spectrum of investment options backed by the proper tools, financial advisors can attract and service a more diverse group of investors. At LPL, we offer multiple private wealth management platforms, variety, competitive pricing, advisory platform tools, and training to help advisors establish their competitive edge. Advisors should only recommend an advisory account if it is suitable for the client. Advisory accounts may not be appropriate for every client. For example, if a client has a small portfolio and prefers to follow a buy-and-hold strategy for a long period of time without ongoing advice, a brokerage relationship may be more appropriate. If the client prefers to make the investment decisions and is looking for a financial advisor to only provide occasional recommendations and execute orders, a brokerage relationship may also be more appropriate. Advisors need to understand that advisory relationships involve a higher standard of care than brokerage and typically require an ongoing duty to provide advice and monitoring. LPL FINANCIAL 7

YOUR PRACTICE, YOUR WAY However you envision the future of your practice or program, LPL s comprehensive support and broad range of innovative business models can help you build and grow your business, your way. LPL understands that independence doesn t have one single meaning. Whatever lens you view your independence through, LPL is here to support and provide clarity to that vision. Here are just a few ways how: Be an independent financial advisor at LPL with access to custodian services and a fully integrated platform to address the varied needs of your clients. Leverage the LPL Hybrid RIA model, which allows you to join LPL s broker/dealer platform while maintaining your RIA firm. Join an existing practice, bank, or credit union for established infrastructure, structured support, and access to new referral sources. Specialize in retirement plans and leverage tools and resources built by retirement plan advisors, for retirement plan advisors. Bring your entire practice or build one LPL offers customized clearing, advisory platforms, and technology solutions to help create efficiencies and scalability within your practice. LPL is committed to your success. Give LPL a call today at (888) 250-2420, and put their capabilities to the test. 1 Industry Trends Research, a survey of 291 financial advisors, LPL Financial/WealthManagement.com, January 13, 2016. 2 May 22-31 Wells Fargo/Gallup Investor and Retirement Optimism Index survey, 2016. 3 Revenue source: PriceMetrix Insights, Transitioning to Fee, Volume 6, August 2012, www.pricemetrix.com Value Source: Investment News, Accurate Figures Point the Way by Andrew Osterland, June 2013, www.investmentnews.com About LPL Financial LPL Financial, a wholly owned subsidiary of LPL Financial Holdings Inc. (NASDAQ: LPLA), is the nation s largest independent broker/dealer (based on total revenues, Financial Planning magazine, June 1996 2016), an RIA custodian, and an independent consultant to retirement plans. LPL offers proprietary technology, comprehensive clearing and compliance services, practice management programs and training, and independent research to more than 14,000 financial advisors and approximately 760 financial institutions. In addition, LPL supports approximately 4,500 financial advisors licensed with insurance companies by providing customized clearing, advisory platforms, and technology solutions. LPL and its affiliates have more than 3,400 employees with primary offices in Boston, Charlotte, and San Diego. A registered investment advisor, member FINRA/SIPC BD-0100-1216 Tracking #1-536716 (exp. 11/18) LPL FINANCIAL 8