The profitability of independent financial advisory firms is higher than it’s ever been. But it’s reaching levels that are unsustainable and can create self-destructive trends in the industry.

The “True Ensemble Data Insights” study, conducted by the Ensemble Practice LLC and BlackRock, surveyed 240 independent financial advisory firms on their operating results in 2023, also looking at their compensation and plans for that year. The results show an amazing return on investment for the owners of the firms—but also showed slow growth and a dangerous increase in employee turnover. The results suggest that mergers and consolidation in this industry will only speed up and intensify as the high profits drive high valuations, which make internal transitions of ownership to employees difficult, if not impossible. What’s more, considering that clients tend to stay with their advisors, the slow growth on one hand and the profitability on the other will encourage firms to poach one another’s advisors. That could damage the firms’ culture and the industry’s collaborative spirit.

The truth is that what’s driving advisory firms’ outstanding profitability is the client households that were added many years ago. Those clients have quietly doubled and tripled their portfolios and fees while over time asking for less service as their relationships travel smoothly “on the rails” of financial plans that were created 10 years ago (and need only regular updates). The attractive results come from a combination of factors: a recurring revenue pricing method, our high client retention and our up-front investments in those relationships (which became easier to service over time). For those results to be sustainable, though, we will need to keep adding clients. And that will require perhaps more capacity than we currently have.

Those are big statements. Let’s support them with some data.

Amazing Profits
The average operating profit of a firm participating in the “True Ensemble Data Insights” study was 36.4%. That figure is higher than any other we’ve seen in similar surveys. (See figure 1.)

 Small firms (those with assets under management of less than $500 million) had a 38.0% profit margin. Medium-sized firms with AUM between $500 million and $1 billion had a profit margin of 41.4%. Large firms with over $1 billion in AUM had operating profit of 34.8%.

Consider a similar study conducted by Investment News and Moss Adams LLC in 2013 that found the average profitability was 18.1% for the participating firms. The smallest firms in that study had a profit margin of 27.4%, while the largest ones saw 17.1%. Medium-sized firms were operating at 19.1%.

In other words, as the size of the average advisory firm has increased by nearly 70% (the average firm had revenue of $3.4 million in 2013 and $5.2 million in 2023), the profit margin has also nearly doubled. This great result was not driven by economies of scale, though. It simply came from the great productivity of the teams.

Amazing Productivity
In 2023, a relationship manager (an experienced advisor or senior advisor responsible for a client relationship) was generating between $765,000 in a small firm and $1,131,000 (I’m rounding here) in a large firm. Medium-size firms saw $927,000 per advisor. (See figure 2.)

The same relationship manager was paid between $160,000 and $335,000 in total compensation, including salaries and bonuses. Those were the median total compensation numbers for senior advisors and advisors. This means that the gross margin—the revenue minus the professional compensation for the relationship managers—is anywhere from 70% to 80% (one minus either $160,000/$765,000 or $335,000/$1,131,000). This is where profitability comes from. When you start with an 80% gross margin you can certainly expect to end with 35% or more in net profit, especially since advisor compensation is the largest expense.

The average advisor in the average firm is working with approximately 120 clients. In large firms the number increases to 138 clients and in medium-sized firms the number is lower at 117 clients per relationship manager. While different studies use different methodologies, it appears that the number of clients has not increased dramatically in the last 10 years.

The big difference is that the clients we had 10 years ago are generating a lot more revenue than before.

Amazing Revenue Per Client
The average client of the typical advisory firm paid $11,000 in fees in 2023. At large firms, the average revenue per client household was $14,864, while small firms saw $5,390. Midsize firms generated $9,897. (See figure 3.)

You can clearly see one of the equations that define an advisory firm.

Revenue Per Client x Number Of Clients = Total Revenue

$11,000 Revenue Per Client x 120 Clients Per Advisor = $1,320,000 In Revenue Per Advisor

This is the simple equation that drives all the profits. But there’s another equation to consider:

Hours Per Client x Total Number Of Clients = Total Hours Of Client Work

How many hours in a year do you need to service a financial advisory client? This is an interesting question. If a firm spends on average 20 hours of the relationship manager (advisor) time on a client, then the relationship manager would need 2,400 hours for all the clients. That’s an unsustainable workload.

In fact, in our experience, a professional would not really have more than 1,600 hours to work with clients if they were to spend another 200 hours improving their own expertise and managing their team, plus 200 hours marketing and developing new business.

If that’s the case, then a relationship manager is spending on average about 13 hours per client and generating almost $15,000 in revenue, an outstanding “billable rate” of well over $1,100 per hour that most attorneys and CPAs would envy.

But that result conflicts with what we hear from wealth managers and financial planners when we talk about the needs of client relationships. When consultants such as Julie Littlechild (the founder of Absolute Engagement) have tried to quantify the number of hours needed to service a client relationship, usually the result is between 20 and 40 hours per year. That’s much more than the 13 we came up with.

The Good Ol’ Client
The reality is that it’s only the first year or two of our client relationships that are the most intensive and consume a lot of time. This is when the initial financial plans get created and dozens of hours go into the financial planning software. This is when the original portfolio is conceptualized and traded, with the taxes carefully managed. This is where life insurance policies are examined and perhaps purchased. This is when estate plans are set. Later, the software will rebalance and trade. Later, the financial planning package will keep updating. Later, the plans set continue to do their job.

In other words, it is likely the first year that requires the 40 hours. The relationship then settles in the grooves and needs much less. And it’s those established relationships that then drive our profitability.

Yet every firm has two limits: 1) its capacity to service existing clients and 2) the time and staff to on-board new clients. The second activity is much more time-consuming than the first. We might already be stretched on our service ability, and we have very little time to on-board.

In previous articles, we’ve rung the alarm bells about the industry’s slow growth, specifically the 5.7% net new client growth in AUM. The sluggishness might be due in part to our lack of marketing time, but it’s also because we simply don’t have much time or staff to on-board clients.

The Logical Consequence
So in a market where profits are very high, productivity is very high … but organic growth is pretty low, what would be the logical strategy? The answer is straightforward. You either buy the “cash cow” firms—if you can find them at the right price (and high-profit, slow-growth businesses are the definition of cash cows, according to Boston Consulting Group). Or you recruit the professionals who can perhaps bring their clients along.

If we continue on this path, it’s only a matter of time until we see intense recruiting wars, with firms trying to poach professionals from one another. After all, if an advisor in a large firm is able to generate $1.3 million for $300,000 in pay, perhaps I can offer that person $400,000 instead and then recruit their clients. With a 36.4% profit margin I can certainly afford to. In fact, it may be a better use of capital than buying the revenue at the high valuations.

Historically, independent firms have not engaged in recruiting wars (conflicts that instead tend to rage among large, branded firms). While large firms recruit from one another with forgivable bonuses of 200% of revenue or higher, independents have shied away from that kind of behavior, perhaps thinking it runs against their culture (or even that it’s in poor taste). After all, if you live by the sword (by recruiting) you may die by it too (by getting your advisors stolen). Some independents have also staved off talent wars by offering equity to their best advisors.

But these bulwarks against change might be changing.

First, independents are no longer small or poorly capitalized. Many are voracious buyers with deep private equity pockets. They are willing to write checks if they see the return on an investment.

Second, equity at advisory firms is becoming less and less accessible to employees. High valuations make it expensive to buy in, and consolidation is making shares less available. Instead, professionals today are receiving either synthetic equity or equity in the holding company of their acquirers rather than the traditional shares of the firms where they’re actually working. These instruments are financially effective but don’t have the emotional staying power of real firm shares.

You can tell where this is heading. The recruiting wars are near. Advisor turnover is already starting to rise. Between 11% and 13% of senior advisors and advisors changed jobs in 2023. This is much higher than anything we saw before the Covid pandemic. We are also starting to see headlines about large, acquisitive firms suing rivals for poaching their professionals.

The lines have also started to blur between independents and their old enemy, the wirehouses. Some advisors have been employed in the last decade by firms of all sizes—small independents, large acquirers and large wirehouses—without even changing jobs. They were just bought and absorbed into different organizations. If the cultural lines are blurring, it is likely only a matter of time until somebody decides that an acquisition strategy that works in a wirehouse can also work in a large, national, branded independent.

So profits are high, growth is low, and fierce recruiting is around the corner. Turbulence is expected. But in the meantime, the drinks in first class are exceptional.

Philip Palaveev is the CEO of The Ensemble Practice, the leading business consultants to the financial advisory industry, and founder of the G2 Leadership Institute, a leadership program that trains the next generation of leaders.