What is a wrap account and what are the advantages of using one?

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December 2016
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The other responses to your question do a good job of explaining the structure of a wrap fee, so I'll simply add that you should be aware of a few of the following implications of having your assets managed this way.

The first implication is simple: you prefer to have someone manage your assets for a fee rather than managing them yourself.

Next, you believe that it will benefit you to pay a larger management fee to have the advisor cover both management AND trading costs. This benefit is most likely realized if you believe that a strategy with more trading is effective in both investment performance and the fact that you wouldn't directly be covering the trading commissions.

Third, be aware of something called "reverse churning." If the advisor is footing the bill for trades, but is charging you a wrap fee, they have an incentive to trade your accounts less in order to limit their expenses and earn higher profits. I would tend to agree that limited trading or limiting costs, in general, is a good thing for investment performance, but if this is what you believe, you might consider whether or not you're better off not paying a wrap fee and just paying the trading commissions yourself. I believe it's important for investment advisors to limit conflicts of interest where they may arise and this structure can promote more complications.

Fourth, a wrap fee structure is less advantageous when the assets managed are larger. Simply put, it costs the same trading commission to buy 1 share of stock or 1,000. But since the wrap fee is often a percentage of assets managed, the benefit of the fee is diminished as the pool of assets is larger, assuming the same strategy is being employed.

Lastly, if you do engage in a wrap fee arrangement with an advisor, do the following annual checkup to see how you're faring. Take the difference between the wrap fee rate and non-wrap fee rate (if they offer one), then multiply that number by your average assets being managed for that year. This will give you a rough estimate of the fees you paid to pay for the wrap feature. From there, review that year  trading history in Stocks/ETFs, Mutual Funds, Bonds, and Options. Determine the fee you would have paid for each trade and multiply by the number of trades in each category. This simple analysis will give you either the premium or discount you're receiving by being in the program. It will also be worth evaluating this in the context of your investment performance.

If you would like clarification of the above or would see value in a second opinion, please feel free to reach out. 

Best, 

Adam Harding, CFP

December 2016
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