The booming RIA industry is tied closely to its embrace of fiduciary duty, which mandates that advisors act in the best interest of their clients.
The regulatory framework of trust and accountability distinguishes RIAs from brokers, and every year the RIA channel commands a larger and larger piece of the wealth management pie.
Almost every breakaway advisor leaving the wirehouse world leads their pitch to clients with: ‘As an RIA, I am a fiduciary, and the firm I just left wasn’t, so you will be better served by moving your assets to my new firm.’
Yet, as the RIA business gets bigger, and its clientele spans a wider wealth spectrum, it is also becoming clear that some RIAs are harming their practices, hence their clients, by misinterpreting their precise legal duties.
Fiduciary duties
The Investment Advisers Act of 1940 is a federal law that states wealth managers must prioritize their clients’ interests over their own and avoid conflicts of interest that could impact the client’s financial goals.
For example, an advisor cannot recommend certain investment products that generate higher fees for themselves, if those products are not the best option for the client.
Or, another example: an advisor must disclose any financial relationship with the issuer of a product before recommending it to a client, guaranteeing transparency prior to the client’s investment.
No one can argue with these policies and practices put in place to protect the client. Thankfully, whether mandated by regulation or not, most advisors in our industry put their clients’ well-being ahead of their own.
As the growth of the RIA industry has shown, putting the client first is simply good business, as that is how you earn trust and build a reputation as a client-first advisor.
Question of quality
Unfortunately, RIAs often take this client-first principle to an extreme and believe that if a particular service is offered to one client, it must be provided to all, regardless of the size of their portfolio or how much they pay in fees.
This breakdown comes because – as a mentor recently said to me: ‘”Fiduciary” has become synonymous with “charity.”’ As a reminder, charity is the “voluntary [uncompensated] giving of help, typically in the form of money, to those in need,” says the Oxford Dictionary.
Charity is not demanded from an advisor and – in the context of a business – is bound to reduce the quality of advice, not least by jeopardizing the enterprise itself.
For instance, many RIAs have established thresholds for offering alternative investments, stating they do not provide these options to clients with less than $5 million in assets with the firm.
Despite this stated policy, many firms continue to offer alternative investments to clients with lower asset levels, and, therefore, lower fees for firms charging based on an AUM fee model.
RIA owners offering these complex investments to clients below their stated minimum are not thinking of the cost to the firm.
Managing relationships
Operations and performance reporting teams must manually update performance reports ahead of every meeting with these clients, or client service teams must scramble to locate K-1s for each of these investments and coordinate delivery to clients’ accountants.
The extra operational burden is justified with a client paying $70,000 per year, but may not be economically practical for the RIA to provide this extra service for a client paying $7,000 per year.
And yet, plenty of low-paying clients continue to be offered these complicated investment vehicles.
In today’s competitive financial landscape, understanding and successfully managing client relationships is paramount. Recent research by Fidelity highlights a critical aspect of this management: the cost to serve clients.
The national average cost to serve a client, according to Fidelity, stands at $9,222.
For firms located in major metropolitan areas, where employees command higher salaries than the national average, this figure can be even greater.
As such, many firms need to re-evaluate their service offerings and fee structures to ensure profitability and sustainability at the client level. Otherwise, profitable clients are merely subsidizing unprofitable ones.
Understanding Segmentation
Client segmentation involves categorizing clients into distinct groups based on shared characteristics or needs.
This approach allows firms to tailor their services and communication strategies effectively. By recognizing that not all clients require the same level of service or expertise, firms can allocate resources more efficiently.
Sadly, many RIAs forget that profitability must also be factored into this client segmentation equation.
For instance, if a client is paying $7,000 annually, it becomes essential to tailor the service offering to meet their specific needs without compromising the firm’s profitability. (A client paying $7,000 is a charitable account for your business, because it does not cover the $9,222 cost to serve, according to Fidelity’s data.)
While comprehensive services like tax planning are valuable, they may not be feasible to include within a standard management fee for clients who do not meet a certain revenue threshold.
In this case, implementing a $10,000 minimum fee for certain services assures that the firm can maintain its service quality while also covering its cost to serve.
Enhancing service delivery
Or, the RIA can choose to charge a separate tax planning fee for clients whose AUM fee is less than $10,000. This allows the firm to remain profitable while still providing value to clients who may not have the AUM to cover extensive services.
By doing so, firms can avoid the pitfalls of overextending resources on clients who do not contribute sufficiently to the bottom line.
The topic of client segmentation is often fraught with controversy.
An older RIABiz article pointed out that some RIAs have called the practice, “cherry-picking, cream-skimming, counterproductive, or just plain mean,” suggesting that it reflects a profit-first, rather than a client-first, mentality by the firm.
However, this perspective overlooks the fundamental purpose of client segmentation — to enhance delivery of service.
At its core, client segmentation is about finding a way to serve more clients as the business grows and serving them in the best way possible. You want the firm’s 101st client to feel as valued as the very first client.
Optimizing resources
However, if you can’t afford enough staff or technological resources to support that 101st client, client service declines for all clients across the book of business, as resources are spread too thin. We have taken a concept rooted in “good business” and turned it into the driver of bad economic business decisions.
Client segmentation is not about excluding clients based on their wealth; rather, it is about optimizing the allocation of finite resources—both human and technological—across a diverse client base.
Moreover, segmentation allows firms to identify high-value clients who may benefit from additional services or products. By focusing on these clients, firms can drive growth and profitability.
By strategically segmenting clients, firms can focus their efforts where they will have the most significant impact, ultimately serving more clients effectively and making sure the business stays afloat.
Improving profitability
The challenge lies in reconciling the misguided interpretation of fiduciary duty with the practicalities of client segmentation.
It is essential to shift the narrative from one of regulatory obligation to one of strategic service. By recognizing that not all clients require the same level of service – or can afford it – advisors can better allocate their time and resources.
This approach not only enhances client satisfaction but also allows firms to operate more efficiently.
By adapting our understanding of the fiduciary duty to embrace segmentation as a means of better serving clients—rather than excluding them— firms can fulfill their fiduciary obligation while improving overall service quality, not to mention profitability.
Understanding the costs associated with different client segments allows firms to tailor their services accordingly, ensuring they remain competitive in an evolving industry landscape.
With the dawn of 2025, it’s time to redefine fiduciary duty and embrace a more strategic approach to service delivery.
This article originally appeared on RIABiz.com