Everybody likes to think he's getting special treatment. That may help explain the popularity of "wrap" accounts, which claim to give investors more specialized treatment than they would get from mutual funds.
With a wrap account, if you have $50,000 to $100,000 or more to invest (many recent retirees do), a broker will interview you, evaluate your needs and risk tolerance and select a money manager for you from a list of independent firms.
Normally, these managers take only accounts of $1 million or more, but they're jumping at the chance to handle these smaller wrap accounts.
No wonder. Investors have put $20 billion to $30 billion into wrap accounts, and the figure could swell to $700 billion by 2000.
If that happens, the fees to brokerages could total $14 billion to $21 billion. That would be welcome help for a business that has seen direct ownership of stocks by individuals drop by more than one-third since 1965 as people moved out of brokerage accounts and into mutual funds or retirement programs such as 401(k) plans.
But are wrap accounts really all that special?
No, argues Harold Evensky, a financial planner in Coral Gables, Fla. "There's a whole slew of problems with wrap accounts" he says. "A broker is supposed to help you review and select a single money manager. That's inherently poor investment planning. To use a single manager is bad planning."
People with $50,000 to $100,000 should diversify their money among two or three accounts with different managers, Mr. Evensky says.
Another problem is the distribution of the annual fee for the account. Although lower fees can be negotiated, the basic charge is 3 percent of the account balance per year. Thus, if
you've invested $200,000, the annual fee is $6,000. Depending on the arrangement between the brokerage and the money manager, $3,600 of that might go to the brokerage, $1,050 would pay for administrative expenses, while the money manager -- the person who is supposed to make the account special -- gets only $1,140, or about 19 percent of the fee. The rest goes for other expenses, Mr. Evensky says.
"The brokerage firm is getting 80 percent of the money for helping you pick one manager," he says. "That's too much."
If that is all the broker is doing, the fee is too much, but good brokers do more, says Robert Middleton, vice president for marketing at National Financial, a subsidiary of Fidelity Investments in Boston. His firm acts as a clearinghouse, providing back-office support for brokerages that use wrap account managers.
A broker should be giving the client quarterly updates on the performance of the account, explanations of why the account performed as it did, a comparison of the client's manager with other managers and a recommendation to switch managers, if necessary, Mr. Middleton says.
"If you can do that on your own, you should," he says.
Most people can do it, contends Don Phillips, publisher of Morningstar Mutual Funds in Chicago. Even if investors do get a 20 percent or 30 percent discount off the wrap fee, he says, they are still paying 2.1 percent to 2.4 percent a year. Mutual funds provide the same basic service -- investing your money -- for 1 percent to 1.5 percent a year, or as little as 0.50 percent.
Although wrap accounts provide quarterly reports, mutual funds have to record their performance in the newspapers every day, Mr. Phillips notes. Also, there are no third-party evaluators, such as newsletters, Morningstar or Lipper Analytical Services, to provide independent assessments of the performance of wrap accounts.
In addition, periodicals such as Forbes, Business Week, and Barron's frequently analyze mutual funds. Barron's for example, has a quarterly issue that shows how $10,000 would have increased or decreased in value for the last three months, 12 months and five years.
Finally, Mr. Phillips contends, the best money managers at the best firms are not managing private accounts, but are running the highly visible public mutual funds. If a wrap-account manager makes a mistake, few people know about it, but with a mutual fund, an error is well-publicized, he says.
Last year, for instance, Vanguard's Windsor II fund slipped because its manager John Neff, regarded as one of the best in the business, had too much money in bank stocks.
Wrap accounts should be seen as a supplement to mutual funds, not a replacement, says James P. Owen, managing director of NWQ Investment Management Co., a Los Angeles firm that says it manages more than $4 billion for wrap-fee investors, as well as middle-market and institutional clients.
"Mutual funds were designed for the 'man on the street,' the small investor just starting out," not the person with $100,000 to $2 million or more to invest, he says.
However, many mutual funds frequently receive initial investments of $100,000 and more, so big investors are not foreign to them, industry observers note. Load funds, in fact, have a series of "break points" where the commission steadily declines as the investments get larger. At $2 million, many load funds become no-loads.
"Wrap accounts are not for everyone," Mr. Owen agrees. Many investors do an excellent job of selecting and monitoring one or more mutual funds, but many others have neither the time nor expertise for this, he says. Also, even if an investor doesn't negotiate down the 3 percent fee, the fixed fee removes any incentive a broker might have to "churn" an account, generating commissions by frequently buying and selling.
Investors should try to negotiate a lower fee, says Barry Vinocur, editor of Stanger's Investment Advisor. "You don't have to pay 3 percent," he says. "Frequently there is the ability to negotiate lower fees. Most consumers don't know that."
Mr. Vinocur thinks wrap accounts make sense for some people but that the trend of some wrap accounts to set lower minimums does not. "These are not for people in the $50,000 to $100,000 range," he says. Some firms have even cut the minimum to $25,000, which Mr. Vinocur says is "ridiculous."
However, at around $250,000, "they probably do make sense," he says. At that point, an investor can get enough diversity, can negotiate lower fees and may get better attention than those with smaller amounts.
Before being sold on a wrap account, though, see if you can do at least as well by picking two or three mutual funds. Most wrap-fee managers follow a balanced approach, where they buy stocks and bonds, which is exactly what balanced mutual funds do.
If you're not sure you can pick funds on your own, pay a fee-only financial adviser a one-time charge to help you pick some no-load funds.
Or, if you have a broker you like, pay him or her a front-end load the first year to help pick a load fund.
If you hold it for several years, the total cost will be less than the 3 percent wrap fee, which is paid yearly.