What is a Wrap Account?
A brokerage firm will professionally manage an investment portfolio for a flat fee quarterly or annually. The charge is based on the total assets under management (AUM). It is all-inclusive, covering all account-related commission, administrative, and management costs.
Around 1% to 3% of AUM is allocated to wrap fees.
Over time, a wrap account turns out to be less costly for many investors than a brokerage account that levies costs on trading activities. A commission-based pricing structure, however, can be more advantageous for the buy-and-hold investor who seldom sells assets.
Understanding the Wrap Account
The benefit of a wrap account is that it shields the investor from overtrading, which happens when a broker makes disproportionate purchases and sales of account assets to increase commission revenue. We call this “churning.”
As they receive a percentage fee based on the total value of the assets in the account, brokers in wrap accounts have an incentive to maximize return on investment.
Traditional Accounts vs. Wrap Accounts
An individual investor may access professional money managers via a wrap account; these managers mainly deal with institutions and high-net-worth people. Additionally, mutual fund companies offer wrap accounts with access to various mutual funds.
A minimum investment of $25,000 to $50,000 may be necessary for a wrap account. The initial investment requirement is often substantially lower for a wrap-fee mutual fund account.
Long-term stock buyers and holders could benefit more from a typical fee structure.
The fees cover distribution and marketing expenses and paying brokers for their services in selling the funds to customers. An investor with a mutual fund wrap account will also be charged this fee.
Particular Points to Remember
A wrap account is ideal for investors who like advisory and hands-on management. Regarding a stock portfolio, investors who use a purchase-and-hold strategy could be better off covering the account’s sporadic trading expenses.
An income-oriented investor, for instance, can own a portfolio of dividend-paying stocks and bonds and make little to no adjustments over the years. The cost basis of each asset may be far lower than the current market price, so if the investor sells the stocks, they may have to pay hefty capital gains taxes.
It might be preferable for the investor to keep the portfolio to get dividend income. There are no commissions or wrap fees to pay, and there are no capital gains taxes.
In this instance, transferring the assets into a wrap account would have resulted in more expenses and a lower overall return for the investor.
Conclusion
- The total assets under management determine the flat cost for brokerage services in a wrap account.
- A wrap account could be less costly for frequent investors than one that levies commissions on each transaction.
- The broker’s goal with a wrap account is to increase profits instead of making money from trade fees.
