I’m Brad Wales with Transition To RIA. This is video #33 of the Transition To RIA video series where I answer RIA related questions I get from advisors just like you. On today’s video I explain if, and how, it is possible to charge performance based fees as a Registered Investment Advisor (RIA).

What I do: At Transition To RIA I help financial advisors understand everything there is to know about WHY and HOW to transition their practice to the Registered Investment Advisor (RIA) model.


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🔹 Transcription of video:

Can an RIA charge performance fees? That is today’s question on the Transition To RIA video series. It is question #33.

Hi, I’m Brad Wales with Transition To RIA where I help advisors like you understand everything there is to know about why and how to transition to the RIA model.

In today’s question, we’re going to talk about….“if I were to make that transition to the RIA model, can I charge performance fees?” What I mean by performance fees is – there could be different ways to structure it – a typical way is think of the hedge fund world. The “2 and 20” that basically says there’s a flat amount based on the assets in the account – on the 2 and 20 example of the hedge fund world, they might charge 2% on assets regardless – and then they will also take a 20% – that’s the 20 part – of any profits on the way up.

Sometimes it’s 20% of any profits above a particular benchmark. There’s some nuances in that….every time you do that, you have a new high watermark. If the account value comes back down, they don’t start getting performance fees again until it exceeds the high watermark.

The idea is that there are potential ways to structure that. As an RIA, you can do performance fees. While you might not be 2 and 20 – that’s more in the hedge fund world – maybe you charge a more typical, the proverbial 1% asset-based rate for the client’s account, and maybe you have an arrangement where you get X% of the profits above a particular benchmark. So the short answer is as an RIA, performance-based fees are allowed.

The longer answer, and I’m going to get into that here – this was the whole reason I made this video – is while it is allowed, there are absolutely challenges of doing this. It is not a simple undertaking. There are a lot of things you would want to be aware of before you even consider doing it.

I’m not trying to suggest you shouldn’t, but I think it’s important that you fully understand exactly how this works and fully understanding exactly what the expectations would be before you even consider maybe….”if I go ahead and transition to the RIA model, that is something I would want to do.”

Before I dive into it, I would tell you these challenges, it does result in the overwhelming majority of RIAs out there do not charge performance fees.

You might say….”Brad, how do know that?” And the reason I know, at least from my experience, is I’ve read hundreds of ADVs of RIAs out there. In an ADV, every single ADV there is, in Part 2, there is a specific section that asks and has to address….”Do you charge performance fees?” You obviously provide the answer. I would tell you that out of hundreds and hundreds of ADVs I’ve read over the years – I’m going off of memory here – I venture it’s a single-digit number of them had performance fees or charged performance fees.

It is very rare, but it is doable. I do want to make sure that’s clear. In the RIA world, it is doable. But on this video, I want to walk you through some of these challenges so you can understand why a lot of your peers have decided not to implement that into their practice.

First challenge, only certain “qualified” investors can even enter into that arrangement with you. There are specific standards on net worth and income and things like that. Just because you want to offer performance fees, and because a particular client might be open to it, from a regulatory standpoint, that client has to qualify to even enter into that sort of arrangement. So that adds some complexity to it because obviously, you cannot run afoul of that.

You will absolutely have challenges or problems if the regulators find out you have not met that specific definition and only those clients are the ones you’ve entered into this performance fee arrangement for. So number one is only certain clients even qualify to enter into that arrangement. Con’t….

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