Definition

Wrap account

  • Updated on

What is Wrap Account?

Portfolios that are managed by brokerage firms in exchange for the flat fee are known as wrap accounts. The flat fee charged is calculated on the basis of the total Assets Under Management (AUM) on annual or quarterly basis. The fee covers all management, commission and administration costs.

Generally, the flat fee ranges from 1% - 3%. The investors might have to pay less commissions on the trade in comparison to the fee paid in case of the brokerage account. Moreover, for the investors who rarely sell their holdings and believe in the buy and hold principle, commission-based fee structure is more suitable.

Sometimes, brokers engage in excessive purchase and sales of assets in order to generate commission income, which is also known as churning. Wrap account protects the investors from churning as it is a commission based account. The broker is only paid percentage of the AUM and thus in wrap account the incentive is to generate higher income from the amount invested.

Highlights
  • Portfolios that are managed by brokerage firms in exchange for the flat fee are known as wrap accounts.
  • The investors might have to pay less commissions on the trade in comparison to the fee paid in case of a brokerage account.
  • Wrap account protects the investors from churning as it is a commission based account.

Frequently Asked Questions (FAQs)

How to invest in a wrap account?

The investment in the wrap account is dependent upon the client’s investment goals. For instance, a risk seeking client’s wrap account might be dominated by equity holdings. However, the wrap account of risk-averse might be dominated by bonds. The investments in the wrap account can be individual stocks, bonds, exchange traded funds, mutual funds and so on. However, the investor should consider following aspects while investing in the wrap account.

Fees – The wrap account flat fee does not include the fund fee that is applicable when investment is made in any kind of funds such as mutual funds or exchange-traded funds. Thus, fund fee will be charged along with the flat fee of the wrap account.

Funds transfer – When the investment in the wrap account is a priority of the brokerage funds, then the investor will not be able to transfer the investment from the wrap account to another investment firm’s account.

What are the special considerations in the wrap account?

For those investors who are looking for a combination of advice and management of the portfolio, a wrap account is most suitable. On other hand, for those investors who adopt buy and hold strategy, then it is better to adopt the traditional accounts as the only trading fee will be incurred occasionally.

Lets’ understand the same with the help of an example. Suppose, there is an income-oriented investor who uses buy and hold strategy as his/her focus is to earn income through bonds and dividends. Therefore, he/she introduced no or very little change in the portfolio. If the investor opens a wrap account, then he/she has to pay a wrap account fee.

If the investor sells the holding in the open market then he/she will need to pay capital taxes.

Therefore, it is generally suggested that in such cases the investors should not choose a wrap account and should focus on dividend and interest as an income stream as it will save the investor from wrap fees and capital gain taxes.

Image source: © Nito100 | Megapixl.com

What is the difference between wrap account and traditional accounts?

When an investor invests in a wrap account, then they get access to expert money managers who have experience in handling the finances of high-net-worth individuals and institutions. Wrap accounts are also offered by mutual fund institutions and provide access to a large pool of mutual funds.

Generally, the minimum investment in a wrap account ranges from $25,000 - $50,000. However, the wrap mutual fund account has lower minimum balance requirements.

The fee of a broker, marketing and distribution is not included in the fee of mutual fund wrap accounts. These are additional charges that investor has to pay.

What is the difference between a full-service brokerage account and a wrap account?

A full-service brokerage account is an alternative to the wrap account. Like, wrap account, a full-service brokerage account is also managed by a professional broker. The noticeable difference between the two is because of the fee structure. In a wrap account, a flat fee is charged, whereas, in a full-service brokerage account, the fee is charged on the basis of trade along with charges of administration and management fees.

Wrap account removes the chances of churning, and full-service brokerage account the investor will be liable to pay less if the trading is done in a modest manner.

Image source: © Madartists | Megapixl.com

What are the advantages of a wrap account?

The biggest advantage extended by the wrap account is that churning can be avoided. As a result, the investor will be protected from paying extra money to the broker and will be able to invest in an asset for a longer duration.

The investor will be able to track the fee he/she will be paying to the broker as at the time of investing in the wrap account, the percentage is fixed by the broker. As long as the investor utilises the service, the percentage of the flat fee will remain fixed.

Moreover, the initial investment requirement of a wrap account ranges from $2,000 to $25,000, unlike many other investments like mutual funds. This makes the service accessible to the middle class as well.

What are the disadvantages of a wrap account?

The broker’s fee is fixed and it is a disadvantage as the investor is required to make the payment irrespective of the work done by the broker. Moreover, if the broker is dedicated and works in a proper manner, then also the broker is benefited. With the increase in the returns the Asset under Management increases and thus the fee of the broker also increases. Thus, the majority of the rewards are enjoyed by the broker only.

Lastly, the 3% fee is very high in comparison to the commission charged by any broker.