Objective information about financial planning, investments, and retirement plans

Are Brokerage Wrap Accounts a Good Idea?

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A reader recently emailed a question regarding a brokerage wrap account he had inherited from a relative.   He mentioned that he was being charged a one percent management or wrap fee and also suspected that he was incurring a front-end load on the A share mutual funds used in the account.

Upon further review we determined that the mutual funds were not charging him a front-end load.  Almost all of the funds being used, however, had expense ratios in excess of one percent plus most assessed 12b-1 fees paid to the brokerage firm as part of their expense ratios.

Are brokerage wrap accounts a good idea for you?  Let’s take a look at some questions you should be asking.

What are you getting for the wrap fee? 

This is the ultimate question that any investor should ask not only about wrap accounts but any financial advice you are paying for.

In the case of this reader’s account it sounds like the registered rep is little more than a sales person who put the reader’s uncle into this managed option.  From what the reader indicated to me there is little or no financial advice provided.  For this he is paying the brokerage firm the one percent wrap fee plus they are collecting the 12b-1 fees in the 0.25 percent to 0.35 percent on most of the funds used in the account.

Before engaging the services of a financial advisor you would be wise to understand what services you should expect to receive and how the adviser and their firm will be compensated.  Demand to know ALL aspects of how the financial advisor will be compensated.  This not only lets you know how much the relationship is costing you but will also shed light on any potential conflicts of interest the advisor may have in providing you with advice.

What’s special about the wrap account? 

While the reader did not provide me with any performance data on the account, from looking at the underlying mutual funds it would be hard to believe that the overall performance is any better than average and likely is worse than that.

Whether a brokerage wrap account or an advisory firm’s model portfolio you should ask the financial advisor why this portfolio is appropriate for you.  Has the performance of the portfolio matched or exceeded a blended benchmark of market indexes based on the portfolio’s target asset allocation?  Does the portfolio reduce risk?  Are the fees reasonable?

What are the underlying investments? 

In looking at the mutual funds used in the reader’s wrap account there were a few with excellent returns but most tended to be around the mid-point of their asset class.  Their expenses also tended to fall at or above the mid-point of their respective asset classes as well.

Looking at one example, the Prudential Global Real Estate Fund Class A (PURAX) was one of the mutual funds used.  A comparison of this actively managed fund to the Vanguard REIT Index Fund Investor shares (VGSIX) reveals the following:

Expense ratios:

PURAX

VGSIX

Expense Ratio

1.26%

0.24%

12b-1 fee

0.30%

0.00%

 

 Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years

PURAX

14.03%

14.47%

11.12%

6.66%

VGSIX

30.13%

16.09%

16.84%

8.41%

 

While the portfolio manager of the wrap account could argue the comparison is invalid because the Prudential fund is a Global Real Estate fund versus the domestic focus of the Vanguard fund I would argue what benefit has global aspect added over time in the real estate asset class?  Perhaps the attraction with this fund is the 30 basis points the brokerage firm receives in the form of a 12b-1 fee?

Looking at another example the portfolio includes a couple of Large Value funds Active Portfolios Multi-Manager A (CDEIX) and CornerCap Large/Mid Cap Value (CMCRX).  Comparing these two funds to an active Large Value Fund American Beacon Large Value Institutional (AADEX) and the Vanguard Value Index (VIVAX) reveals the following:

Expense ratios:

CDEIX

CMCRX

AADEX

VIVAX

Expense Ratio

1.26%

1.20%

0.58%

0.24%

12b-1 fee

0.25%

0.00%

0.00%

0.00%

 

Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years

CDEIX

10.01%

NA

NA

NA

CMCRX

13.11%

19.30%

12.98%

5.78%

AADEX

10.56%

21.11%

14.73%

7.57%

VIVAX

13.05%

19.98%

14.80%

7.17%

 

Again one has to ask why the brokerage firm chose these two Large Value funds versus the less expensive institutionally managed active option from American Beacon or the Vanguard Index option.  I’m guessing compensation to the brokerage firm was a factor.

Certainly the returns of the overall wrap account portfolio are what matters here, but you have to wonder if a wrap account uses funds like this how well the account does overall for investors.

The lesson for investors is to look under the hood of any brokerage wrap account you are pitched to be sure you understand how your money will be managed.  I’m not so sure that my reader is being well served and after our email exchange on the topic I hope he has some tools to make an educated evaluation for himself.

The Bottom Line 

Brokerage wrap accounts are an attempt by these firms to offer a fee-based investing option to clients.  As with anything investors really need to take a hard look at these accounts.  Far too many charge substantial management fees and utilize expensive mutual fund options as their underlying investments.  It is incumbent upon you to understand what you are getting in exchange for the fees paid.  Is this investment management style unique and better?  Will you be getting any actual financial advice?

The same cautions hold for advisory firm model portfolios, the offerings of ETF strategists and managed portfolios offered in 401(k) plans.  You need to determine if any of these options are right for you.

Has your broker suggested a wrap account for your investments and you’re not sure if this is a good deal for you? Approaching retirement and want another opinion on where you stand? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services. 

Peyton Manning and Investing Success

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Updated February 7, 2016. 

It will be interesting to see how Manning does in today’s Super Bowl 50 and whether he retires if Denver wins.

I attended the Envestnet Advisor Summit at the Chicago Hilton in 2014.  Excellent conference, Envestnet offers a robust platform for financial advisors.  A colleague urged me to attend and I’m glad I did.

The highlight of the conference was Peyton Manning’s keynote address on Friday morning.  Regular readers here know that I am diehard fan of the Green Bay Packers, but I think all football fans have to respect Manning’s skill and his character.  His address was about leadership and being a game changer.  I felt that several of his remarks and comments have a direct correlation to being a successful investor.

Peyton Manning

Thrive on discomfort 

Manning made this reference in terms of it being a key trait of game changers.  I think this is a key trait of successful investors as well.

The investing landscape has certainly undergone change and disruption since the beginning of this century.  We’ve experienced the bursting of the Dot Com Bubble, the financial crisis of 2008-09, the Flash Crash and many other disruptions.

Successful investors adapt to change and embrace it to their advantage.  In some cases this means knowing when to change their investing style, in others it means knowing when to stay the course.  It also means knowing how and when to use new investing tools like ETFs and others.

Ask questions 

Manning mentioned this as a key trait of leaders in business and something that he does constantly in an effort to guide his team to even greater levels of success.

Investors should always ask questions.  Some key questions include:

  • Would I buy this particular investment today?
  • Is there a better place for my money?
  • What are your conflicts of interest in terms of advising me to make this investment?
  • How does this investment fit into my overall portfolio?  

It’s over move on after a bad play

Manning cited the uncanny ability of 49ers great Joe Montana to lead his team to a touchdown on the series immediately following his having thrown an interception.

This is a key trait for successful investors to adopt.  I can’t tell you how many investors I’ve spoken to who want to hold a losing position until it breaks even.  The ability to accept an investment loss is critical.  Sometimes it is better to realize a loss and reinvest the proceeds elsewhere.  Even the best investors make bad investing bets.  The successful ones are capable of admitting this and moving on.

Invest in a coach to keep you growing

Manning hired the current Duke Head Football Coach as his offseason coach to help him improve his quarterback skills.  This individual was his offensive coordinator in college at Tennessee.  This is Peyton Manning, 5 time MVP and Super Bowl champion hiring a coach to help him improve his game!

Many investors do a great job of accumulating wealth and managing their investments.  At some point even the most successful ones realize that they might need some outside expertise to take things to the next level.

Perhaps this realization comes as their career and family obligations limit the time they can spend on their investments.  Often this realization comes as retirement approaches.

Hiring a financial advisor is not a sign of weakness; rather it is a sign that you realize the limits of your expertise and the best uses of your time.  If you are at this point here is a guide to choosing a financial advisor that might help you.

Peyton Manning spoke about leadership and did a great job of tying in his experiences as a leader in sports to what financial advisors need to do to lead clients to the successful outcomes they are seeking.  As I listened to him speak I couldn’t help but see the relevance of his message to what I believe it takes to be a successful investor in today’s dynamic investing world.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.

Photo credit:  Flickr

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