A personal finance blog dedicated discussing such topics as budgeting, asset allocation, 401K, IRA, cash flow, insurance, financial planning, portfolio management, and other areas in personal finance.


Thursday, July 14, 2005

What's a Wrap Account?

Basically, a wrap account is an account that can hold mutual funds from different mutual fund families. Full-service brokerage firms like wrap accounts because they can offer their clients different fund families without having the hassles of setting up individual accounts with each fund family. Because the wrap account has it's own fee attached to it, sales charges (commissions) and 12b-1 fees are usually waived.


Average cost of a wrap account nationally is about 1.17% of assets per year. Keep in mind that that 1.17% is in ADDITION to regular mutual fund expenses (minus 12b-1 fees). For example, say you wanted to set up a wrap account and you wanted to invest in American Funds' Growth Fund of America, which usually has a 5.75% sales charge and .76% annual expense ratio. Under a wrap account, American Funds would agree to waive the 5.75% sales charge and also reduce the annual expense ratio by the 12b-1 fee of .25%. So, you would be paying a total of 1.68% per year (1.17% + (.76% - .25%) = 1.68%) for this particular wrap account.

Now, how does that compare with going the regular route of simply paying the sales charge and regular expenses? We'll do a five-year comparison, assuming a $25,000 investment at an 8% annual return reduced by the annual expenses of 1.68% for the wrap account and .76% for the non-wrap account.

To Wrap

You put $25,000 into the wrap account and it immediately goes to work for you. At the end of the first year you have $26,580 (25,000 X (1 + .0623) = $26,580). At the end of five years the balance in the wrap account would be $33,964 ($25,000 X (1 + .0632)5 = $33,964).

To NOT Wrap

If you decided not to go the wrap route, you would pay an upfront sales charge of 5.25%. So, you're $25,000 would be reduced to $23,562 after you paid a front load of $1,438. At the end of the first year, you're balance would be $25,264 ($23,562 X (1 + .0724) = $25,264). At the end of five years, the balance would be $33,419 ($23,562 X (1 + .0724)5 = $33,419).

So, for this example you gain over $500 by going the wrap route. But, there are a couple of things to think about:

  • 1. The more money you have to invest, the more likely you are to qualify for reduced front loads on mutual funds. This can be significant.

  • 2. Even based on this example, with all things being equal, eventually the load account would outperform the wrap account. By my estimation, that would happen about the end of the 9th year.

  • 3. Under the wrap account, the broker has an incentive to work for you since his compensation is paid annually and not in one lump sum at the beginning of the relationship.

  • 4. Additional deposits change everything. I don't have enough time to go into detail here, but you need to consider whether or not you will be making additional deposits into the account. This will affect the outcome.

Final Thoughts

I think wrap accounts can be a good thing. But, you need to really consider all fees associated with the wrap account before you commit your money to it. I hope this post was helpful. I welcome any questions or comments.

Tags: , ,