The Rap on Wrap Accounts -- They Miss the Target

05/25/2011 01:45 pm ET
  • Dan Solin Author of the Smartest series of books

Brokers love wrap accounts (also called "managed accounts"). They are accounts managed by private fund managers. The pitch is that you get access to the "best" managers who normally would not deal with smaller accounts. You are charged a flat fee which averages around 1.17% a year, plus the cost of the underlying funds. Some of the discount brokers offer reduced fees.

When you add the cost of the underlying funds to the mix, the total costs can be north of 2%.

These accounts are popular with brokers because they generate predictable fees for relatively little work. Clients like them because they believe they are getting "superior" fund managers at a fixed cost.

Wrap accounts never made any sense to me. If you want a managed account, try Vanguard's Target Retirement Funds. The underlying funds are all index funds. The expense ratio is a puny 0.19. Historically, these funds have outperformed comparable portfolios of actively managed funds (like those in wrap accounts), largely due to the significant difference in expenses.

Target retirement funds rebalance your portfolio over time to become more conservative as you age.

Lower costs. Better performance. It seems like a no-brainer to me.

Yet over $1.5 trillion is invested in wrap accounts.

The securities industry doesn't know much about investing, but they are great at sales!

I explore wrap accounts in this week's video.

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