Wrap Accounts: An Alternative to Broker's Commissions

What Is a Wrap Account?

A wrap account is an investment portfolio that is professionally managed by a brokerage firm for a flat fee that is charged quarterly or annually. The fee is based on total assets under management (AUM). It is comprehensive, covering all administrative, commission, and management expenses for the account.

Wrap fees range from about 1% to 3% of AUM.

For many investors, a wrap account proves to be less expensive over time than a brokerage account that charges commissions for trading activity. However, the buy-and-hold investor who rarely sells holdings might be better off with a commission-based fee structure.

Understanding the Wrap Account

A wrap account has the advantage of protecting the investor from overtrading, which can occur if a broker buys and sells assets in the account excessively in order to generate more commission income. This is known as "churning."

In a wrap account, the broker is paid a percentage fee based on the total assets in the account and thus is incentivized to get the highest possible return on the amount invested.

Key Takeaways

  • A wrap account is a flat fee for brokerage services based on total assets under management.
  • For active investors, a wrap account may be less expensive than one that charges a commission for every trade.
  • In a wrap account, the broker's incentive is to maximize gains rather than generate trading fees.

Wrap Accounts Vs. Traditional Accounts

A wrap account offers an individual investor access to professional money managers who work primarily with institutions and high-net-worth individuals. Mutual fund companies also offer wrap accounts with access to a large selection of mutual funds.

A wrap account may require a $25,000 to $50,000 minimum investment. A mutual fund account with a wrap fee generally has a much lower initial investment requirement.

Investors who buy and hold stocks long-term may be better off with a traditional fee structure.

The fees pay for marketing and distribution costs as well as the payments to brokers who sell the funds and work with clients. This fee is an additional charge to a mutual fund wrap account investor.

Special Considerations

A wrap account works best for the investor who wants a degree of hands-on management and advice. Investors who use a buy and hold strategy for a stock portfolio may be better off paying the occasional trading fees that the account incurs.

For example, an income-oriented investor may hold a portfolio of dividend-paying stocks and bonds, and make few if any changes for years. If the investor then sells the stocks, substantial capital gains taxes could be owed because the cost basis of each stock may be far below the current market price.

The investor may be better off holding the portfolio to earn the dividend income. No capital gain taxes are incurred, and there are no commissions or wrap fees to pay.

In this case, moving the assets into a wrap account would have generated more costs and reduced the investor’s total return.

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