What is a 'Wrap Account'
A wrap account is used by a brokerage firm to manage an investor's portfolio for an annual fee, which is based on total assets under management (AUM). This fee covers all of the administrative, commission and management expenses for the account. For many investors, a wrap account is less expensive than a brokerage account that charges commissions for trading.
BREAKING DOWN 'Wrap Account'
The advantage of a wrap account is it protects the investor from overtrading, which occurs if the broker trades in the account excessively to make more commission income. Because the broker receives an annual fee based on the total assets in the account, the investment advisor places trades to boost the value of the wrap account over the long term.
The Differences Between Traditional and Mutual Fund Accounts
A traditional wrap account offers investors access to professional money managers who traditionally work with institutions and wealthy individuals. Mutual fund companies also offer wrap accounts as a vehicle to access dozens of mutual fund choices. While a traditional wrap account may require a $25,000 to $50,000 minimum investment, a mutual fund account has a much lower initial investment amount.
Wrap account investors should be aware an investment broker earns a 12b-1 fee on mutual fund purchases in a wrap account. These fees pay for marketing and distribution costs, and a portion of these fees are paid to brokers who sell the funds and work with clients. This fee is an additional charge to a mutual fund wrap account investor.
Factoring in Advice
Before putting funds in wrap account, the investor should consider the amount of advice he needs to manage his assets. Many investors who use a buy and hold strategy for a stock portfolio do not need to incur the annual cost of a wrap account. Assume, for example, an income-oriented investor holds a portfolio of stocks that pays a high level of dividends, and the owner has held the securities for many years. If the investor sells the stocks, the owner incurs large capital gain taxes on the sale because the cost basis of each stock is far below the current market price.
In this case, the investor is better off holding the portfolio to earn the dividend income and avoid the capital gain taxes incurred on the stock sales. In addition, the investor is not incurring commissions or a wrap fee to hold the portfolio, so moving the assets into a wrap account would generate more costs and reduce the investor’s total return.