What is a Wrap Account?
A wrap account refers to an investment account that is managed by a broker for a flat annual fee. The flat annual fee, which ranges from 1% to 3% of assets under management (AUM), covers all expenses related to managing the account, such as administration, commission, management expenses.
- A wrap account is managed by a broker for a flat annual fee, which ranges from 1% to 3% of assets under management.
- The flat annual fee covers all expenses related to managing the wrap account.
- Wrap accounts are a popular option to prevent churning.
Understanding a Wrap Account
Wrap accounts are a type of managed account where an investor pays a flat annual fee to investment professionals to (1) manage their investments in that account and (2) gain access to a number of services. The types of applicable services depend on the brokerage firm, but generally includes:
- Financial planning services
- Investment advice services
- Performance monitoring services
- Trading services
Given that wrap accounts are only charged a flat annual fee, they are a popular option to prevent churning. Churning refers to a broker buying and selling investments in an account for the purpose of generating additional commission (for the broker’s benefit) and without consideration for the client’s investment goals. Furthermore, with a flat annual fee based on AUM, brokers are generally highly incentivized to generate the highest returns possible, which would increase the AUM and fees received.
The main disadvantage of a wrap account is that they require a steep minimum investment amount – usually in excess of $50,000. Such a disadvantage is a byproduct of the flat annual fee structure, as brokers would be reluctant to manage a small AUM, which would result in a small flat annual fee for them.
Wrap Account vs. Full-Service Brokerage Account
A common alternative to a wrap account is a full-service brokerage account. A full-service brokerage account is also an investment account that is managed by a broker. However, the difference lies in the fees – full-service brokerage accounts generally charge commission fees per trade in addition to management and administration expenses.
Although a wrap account removes the potential conflict of interest of churning, a full-service brokerage account with little to modest trading activity would likely result in lower total expenses versus a wrap account. When determining which account to open, it is important to consider:
- The level of expected trading activity
- The wrap account flat annual fee versus the full-service brokerage account fees
- The type of services included in a wrap account
Investments in a Wrap Account
The types of investments applicable in a wrap account depend entirely on the client’s investment goals. For example, a risk-averse client may have its wrap account comprised primarily of bonds, while a risk-seeking client may have its wrap account comprised primarily of stocks. The types of investments in a wrap account can range from individual stocks and bonds to mutual funds and exchange-traded funds.
There are two key considerations regarding wrap accounts:
- Fees on fees: If a wrap account holds funds, such as mutual funds, the associated fund fees will be applicable on top of the wrap account flat fee.
- Difficulty transferring Investments out of the wrap account: In the scenario that investments in the wrap account are proprietary to the brokerage firm, the investor may not be able to transfer the investments in that account to an account at another firm.
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