If you’ve ever planned an exotic beach vacation, you’ve likely considered staying at an all-inclusive resort. Wrap fee programs are the all-inclusive resorts of the financial advisory world. Enrolling in one means you pay a single fee that covers your advisor’s guidance plus additional trading expenses typically associated with a brokerage account.
But is a wrap fee program right for you? If you expect a high trading volume, wrap accounts might make sense. But long-term investors might want to steer clear.
A wrap fee program is an investment account that bundles fees for portfolio management and brokerage services into a single consolidated charge. Accounts can vary in scope and services, but wrap fees typically cover a combination of expenses, including:
Wrap fee programs, also known as investment management programs or asset allocation programs, offer clients certainty and predictability around how much they’ll pay in fees. Investors who don’t pay wrap fees may see their brokerage fees fluctuate based on trade frequency and market conditions.
There’s no one rule dictating what services a wrap fee must include. While some may only cover advisory services and transaction fees, others may include internal expense ratios charged by mutual fund companies and, in some cases, financial planning services.
Luckily, figuring out what a wrap fee program includes isn’t tricky. The Securities and Exchange Commission (SEC) requires registered investment advisors (RIAs) to provide a separate wrap fee program brochure as part of the annual Form ADV filing. This document details which expenses a wrap fee covers, how much the program costs and more.
Like a financial advisor’s management fee, wrap fees get calculated as a percentage of your assets under management (AUM). So, for example, an investor with a $100,000 account would be charged $2,000 per year under a 2% wrap fee.
A conventional advisory fee doesn’t cover your account’s brokerage and administrative expenses. Instead, you pay these fees separately and, generally, directly to the brokerage. With a wrap account, your advisor uses a portion of your fee to pay for all your account’s brokerage fees.
But these all-inclusive programs are by no means a panacea. In 2021, the SEC issued a risk alert warning that these programs can create conflicts of interest for advisors. For example, wrap fees can incentivize portfolio managers to trade less frequently within a client’s account to reduce operating expenses and increase profit margins.
An SEC examination of 100 advisors raised “concerns that clients whose wrap accounts are managed by portfolio managers with low trading activity are paying higher total fees and costs than they would in non-wrap accounts.”
It’s difficult to pinpoint an industry average, but these charges typically max out at 3% of AUM each year, according to the Financial Planning Association.
What’s more important to know is the difference in fees you’d pay with an all-inclusive wrap account versus a regular brokerage account. The answer will likely depend on the frequency and number of trades your advisor executes within your account. The more trading that takes place, the more likely a wrap program will save you money.
The SEC recommends asking your advisor the following questions to determine whether a wrap fee program is appropriate:
It all leads to the question of whether you should enroll in a wrap fee program. Here’s the nitty gritty: Wrap fees benefit certain investors but may cost others more money.
A wrap fee program might make sense if:
A wrap fee program might not make sense if:
Now that you understand wrap programs better, you’re ready to tackle the next phase in your investing journey. Depending on your financial goals and needs, consider these three next steps:
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