How does an RIA custodian generate revenue?

I'm Brad Wales with Transition To RIA. This is video #36 of the Transition To RIA video series where I answer Registered Investment Advisor (RIA) related questions I get from advisors just like you. On today's video I explain how an RIA custodian generates revenue. As the RIA itself receives a 100% "payout" on the client fees they generate, it begs the question as to how the custodian itself generates revenue.
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:
How does a custodian generate revenue? That is today's question on the Transition To RIA question and answer series. It is question #36.
Hi, I'm Brad Wales with Transition To RIA, where I help you understand everything there is to know about WHY and HOW to transition to the RIA model.
Today's question is, how does a custodian generate revenue? I get asked this all the time, and it's usually the second part of...the first part of the question is, is the payout that I would receive as an advisor really 100%? I'll end up doing a whole separate video on that, but the short answer is yes.
As an advisor in the RIA model, you keep 100% of your advisory fee. So in theory, the “payout” is 100% back to you as the RIA. That then leads to the next question…. “well if I'm the advisor, if I'm keeping 100% of the fee, how is the custodian generating revenue? There must be some catch here??”
That's a common question, and I completely understand, and I explain this all the time. I'm more than happy to have a one-on-one conversation about it as well if you'd like, but I did want to do a video because it does come up so frequently. And I'd tell you, this is near and dear to my heart, I spent many years working at a custodian, literally running the budget for the custodian. So I'm well aware of exactly how a custodian generates revenue. And I've had this conversation for years to help advisors understand how it works.
I would tell you, one thing to think about, and we're going to go through each of these revenue sources so you can kind of understand them - and it is not like 20, don't worry. But the main thing to think about is, compared to a broker-dealer environment where as a broker-dealer they have to provide supervision, oversight over you as an advisor, they have to provide this massive compliance apparatus, all kinds of other factors that just aren't relevant in the custodial model, where the custodian does not supervise you as an RIA. The custodian does not do your compliance.
So as we go through these, the thing I always point out to folks is, yes, a custodian...well, we'll take an example. Say an advisor has $200 million in assets, and they're sitting, maybe in a custodial model, or they're sitting in a more traditional broker-dealer model with one of the large firms. For that same $200 million, the broker-dealer will bring in significantly more revenue, top line revenue, because they're taking, among other things, a big payout on the fees and commissions you are generating.
So they bring in a lot more revenue than on that same $200 million that the custodian would bring in. However, the broker-dealer model also has significantly more embedded costs, again, things like supervision, things like compliance. These large firms have armies of people, hundreds of people that they have to pay to do all of these things. And so while that broker-dealer model brings in on that same $200 million in assets on their platform a lot more top line revenue, they also have a lot more expenses that a custodian simply doesn't have.
Even though a custodian brings in a lot less top line revenue, again, they take away a big piece of that cost structure that is just not applicable to them, that is in the broker-dealer world. So it's not to say that at the end of the day their net incomes are the same, but just to give you a framework of how it does work that a custodian, yes, understandably, brings in less revenue. But again, their cost structure to provide the service to RIAs is significantly less, because again, they don't have a lot of these responsibilities that a broker-dealer has.
Related to that, as we get into this and I go through these, I would just remind you, as an RIA, you will be working with a number of different vendors. con't.....
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