What is a wrap account?
The term “wrap account” typically refers to an account that offers unlimited transactions within the account and charges a quarterly or annual fee (usually a percentage of the assets in the account) that covers all investing costs, including any trading costs. A wrap account typically offers suggestions about how to invest those assets based on your investment objectives and risk tolerance.
How does it generally work?
When you decide to establish a wrap account, you (the client) will typically sit down with a financial professional and map out an investment plan based on your risk tolerance and financial objectives. The broker then selects a professional money manager (or managers) who selects an appropriate mix of mutual funds that match your needs. The money manager may work independently or in-house for your brokerage firm, but either way, he or she works through your broker.
How does a wrap account generally work?
There are generally two types of wrap accounts. A mutual fund wrap account is made up of only mutual funds, usually more than one. The selection of those funds typically is based on a computerized asset allocation model that takes into account your financial objectives, age, risk tolerance, and investing time horizon. The portfolio is typically rebalanced periodically to maintain the agreed-on asset allocation. (Similar types of wrap accounts that focus on using exchange-traded funds (ETFs) also exist.)
A nondiscretionary advisory account is a type of wrap account offered by brokerage houses which can hold a broader range of investments–for example, individual stocks and bonds, mutual funds, exchange-traded funds, and cash alternatives. An individual advisor can make asset allocation and investment recommendations as well as monitor your portfolio, but is not allowed to make final decisions without your authorization.
Because of a 2007 U.S. Court of Appeals decision, fee-based brokerage accounts that include investment recommendations may be offered only if they are managed by a registered investment advisor (who may be part of the same firm as the broker).
A nondiscretionary advisory account is different from a separately managed account, in which an investment advisor selects one or more money managers to handle individual investments held in the account but which is typically focused on one asset class.
What are the costs of a wrap account?
Most mutual fund companies offer wrap programs with a minimum investment of between $10,000 and $15,000. But that minimum investment standard is changing. Because of the popularity of wrap accounts, “mini” wraps are appearing among financial houses to attract investors who have smaller portfolios. The wrap fees usually range between 2.5 percent and 3.5 percent of assets annually. Mutual fund wrap accounts tend to offer lower fees; however, if a fund wrap account charges a sales commission, you may have to pay a front-end load when you buy or be liable for a redemption fee when you sell. There may also be underlying mutual fund fees in addition to the wrap fee itself.
Strengths
Investment recommendations
A wrap account gives you access to professional investment expertise. This is a distinct advantage for mutual fund investors who may have substantial assets but not the time, inclination, or desire to develop and monitor their asset allocation strategy themselves.
Eliminates incentive to churn account
Because commissions are not paid each time securities are bought and sold, the financial professional you work with has no reason to make trades simply to increase commissions. The more actively the account is managed, the greater the advantage of eliminating commissions in favor of a flat fee.
Tradeoffs
May provide unnecessary services
If you anticipate that your account will not involve frequent trading, it may be more cost-effective to pay per-trade commissions or sales charges in a regular mutual fund or traditional brokerage account. Also, if you are comfortable with your own understanding of and experience with investments and investing strategy, investment recommendations may not be useful enough to justify a wrap account’s fee.
Lack of flexibility
Your choice of funds in a mutual fund wrap account may be limited to proprietary in-house funds, or just a handful of funds.
