As financial advisors create their own team practices or go independent and set up independent RIA firms, one of the biggest challenges they face is designing a compensation plan for themselves and those who work with them and for them. The problem is that there seem to be unlimited ways to do this, and advisors have to figure out which one is right for them.

Doing so means understanding what their firm's strategic goals are and what sort of compensation incentives are important given the specific talents, skill levels and motivations of the individuals working with them.

There are essentially six steps to take when you're creating your compensation plan. These should be followed in order to gain the most benefit from the process:

Evaluation. First you must conduct a comprehensive evaluation of the compensation plans already out there and develop a feedback report of the findings.

Compensation philosophy. Next, you must define your company's compensation philosophy, which defines how and with whom the company intends to compete for its human resources and how and under what terms its advisors and/or employees will be rewarded. This might mean setting fixed compensation (based on salaries) or it might mean creating variable compensation models (mixing different sorts of pay such as a percentage of assets under management; a percentage of gross dealer compensation; or a percentage of commissions, trails, recurring fees, etc. In most cases, your compensation structure will be a unique blend of some or all of these elements to best match the firm's philosophy.

Job analysis. After that, you should conduct a comprehensive analysis of each person's job to determine his or her primary functions, duties and responsibilities. This analysis will allow you to create a framework to develop market pricing. You should compare the compensation for each position in your firm with the industry's standards. Such an analysis should allow you to understand every person's unique contribution to the success of the firm.

Administration guidelines. The fourth step is to create a salary/bonus/incentive structure and write administration guidelines that let you set pay for each member of a firm and adjust it for performance, future promotions, changes in job function, specialization and changes in market rates.

Incentives and bonus plans. When appropriate, develop incentive or bonus plans that reward participants for hitting specific performance measures and achieving certain goals. Also, develop a financial model of the incentive plan costs that takes into account the different amounts you might actually have to pay out.

Long-term stakeholder plan. When appropriate, you should develop long-term plans that reward the members of your team for creating long-term shareholder value. This means writing up guidelines for granting stock options, stock or other equity instruments or equity-like "phantom" plans, as appropriate for your employees or producers. This often means you must research stock option granting practices in the market (finding out how many shares you should offer, at what price grants are made and how options vest). If long-term plans entail paying cash awards, you should assess how much such awards would cost in different scenarios and develop measures for making sensible long-term cash payments that can be adjusted and changed in different economic circumstances.

Even after you have set down these six steps, however, the plan will not work if your firm can't afford it or if it runs counter to the best interests of your clients. For that reason, any compensation plan must be accompanied by a study of how it fits into the overall strategic initiatives of the firm. This should be done in concert with a cost/benefit analysis to ensure you can pay for the plan. And perhaps most important, you should also perform an impact study on how such a plan would affect your clients.

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