In the late 1960s, Stanford University psychologist Walter Mischel conducted what famously came to be known as the “Marshmallow Challenge.” Nursery school children were given their choice of receiving one marshmallow immediately or two if they would wait until the experimenter left the room and then returned.
The children who waited did better in life. On average they scored more than 200 points higher on SAT tests and evolved into more socially competent young adults.
Perhaps there’s a lesson here for Wall Street. For those advisors who are inclined to establish their own independent firms, and who don’t need the upfront money, the ability to defer gratification can pay off. A recent Reuters piece, reveals that in some cases independent advisors can sell their businesses for twice as much as their broker-dealer counterparts. According to the story, brokerages usually pay 0.85-1.4 times the annual revenue over three or four years. The payout is taxed as if it were a salary. By contrast, independents typically can get 2.25 times their revenue flow — and then it is taxed at the far more favorable capital gains rate.
It may seem like a no-brainer — if you like running your own business, go the independent route. Get the equivalent of two marshmallows later versus one marshmallow now.
In fact it’s not that simple. Advisors who stay in the traditional broker-dealer system can get recruiting packages that far outstrip their independent counterparts. But at every point in the process — whether taking a big deal or selling their businesses at retirement — the broker-dealer model keeps advisors in the ordinary tax bracket. Independents may have more flexibility in determining the sale price of their practices, but they also need to be savvy sellers. I wrote about that earlier this year. You can read about that here.
Broker-dealer advisors don’t have much wiggle room when they sell their practice at retirement. Basically, they get what the boss gives them. But in this competitive world even that is changing. Some wirehouses are trying to devise more flexible guidelines for the sales of advisor practices.
I wouldn’t urge anyone to move one place or another solely on the basis of a payment now or later. There are so many factors that go into making a good match. But if advisors choose to take the marshmallow now, they should do so because the business model makes sense for them. For some, the best play really is the two-marshmallow deal. Similarly, advisors should be able to consider whether it’s better to defer, that down the road they will do better by waiting for their big payday.
