Cute May be a Reason to Date, but Not to Invest

So here is something “cute” on the investment scene–wrap accounts. Wraps not only have a cute name, but they are also based on a “cute” concept. Namely, wraps represent a pre- designed portfolio of mutual funds put together to answer specific investment requirements. For example, there are wraps that provide income, as well as growth wraps for more speculative investors, and also balanced wraps for those wanting a little bit of both.

Wraps are cute even in theory. They are supposed to be one-stop shopping place for mutual funds. Instead of having to design an appropriate match of mutual funds that fit one’s particular investment style, the job has already been done for them by a brokerage or mutual fund company.

But, there’s a catch. Wraps’ “cuteness” comes with a price. Apparently, wraps generate more in broker and management fees than individual funds, which most investors will find hard to swallow. By the same token, the industry must be in love with them, since in the past three years, wraps’ assets under management have grown on average 26.8%. To put things into perspective, assets under management in regular mutual funds have grown at a relatively modest rate of 10.7% per year.

If we were to equate such an outstanding performance to wraps’ intrinsic value, we may run into a problem of justifying the calculation. In this day and age, with so much information available at investors’ fingertips, most do-it-yourself investors can create something of a basket of mutual funds that fit their investment profile. There are even advisors out there willing to the work for you at a fraction of the cost of any wrap.

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So, why are wraps so popular? Simply, fees paid by mutual fund companies to advisers that sell wraps to their clients are quite high. In fact, about 99% of all wraps pay more money to advisers than regular mutual funds. And, as Liza would sing, “Money makes the world go round, the world go round, the world go round.”

In concrete terms, an average equity mutual fund pays about one percent in trailing commissions, while a typical bond fund pays about half of that. In contrast, wraps pay on average 1.25% in trailing commissions, while there are quite a few that pay even more, up to 1.5%. Which begs the question: Who benefits the most from buying a wrap, an advisor or the client?

Wraps are, in so many ways, a lazy kind of investing–not for you, but for your adviser. Someone else has already figured out quite a few things. But you’re not paying that “someone else” the nice commission. No, you’re paying your broker. There are times when it is a good idea to benefit from someone else’s ground work. However, I don’t think that wraps fall into that category.

If your broker suggests you to buy a wrap, ask him very specific questions. For example, ask him why he is recommending a wrap. Ask him to compare the performance of his chosen wrap versus a few similar mutual funds, or a mock portfolio of stocks and bonds. You are paying fees and commissions to your adviser for a reason. Make sure you get your money’s worth, it is your right!