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The Rap on Wrap Accounts: High Costs

As an investor, do you find yourself too busy, bothered or bewildered to make good decisions? If so, you may have heard a sales pitch for a wrap account, which hands most of your money decisions to a pro.

Wrap accounts are offered by many stockbrokers and financial planners, with banks newly getting into the act. They manage your money for fixed annual fees rather than charging commissions whenever you buy or sell.

But before you jump, consider the cost: typically, 2 percent to 3 percent of your assets per year. That sounds like pocket change in a year you earn 20 percent. But it's up to one-third of your stock profits in an average year, and two-thirds of the average profits in bonds. You are simply giving your money away. "It's one of the great marketing gimmicks," said Eli Neusner of Cerulli Associates, a Boston-based consulting firm.

With wraps, you're paying for two layers of money management:

Your cash is invested by private money managers in individual stocks and bonds; or it's placed in a mixture of mutual funds. They typically charge about 1 percent or 1.25 percent a year (and sometimes less).

The rest of your fee -- around 1 percent to 1.75 percent -- goes to the broker or planner who put you into the account. These people advise you on which funds or managers to choose, allocate your investment among different types of funds (often using model portfolios developed by the firm), mail you periodic performance reports and suggest when changes should be made.

Fees are usually lower on all-bond accounts. Together, the broker and money manager may cost 1 percent to 1.5 percent. Some financial planners, who take only fees (and don't collect commissions), may charge the same low amount even for all-stock portfolios.

Investors seem to like the wraps and don't mind (or don't notice) their high cost. At year-end 1995, total wrap assets stood at a minimum of $101.6 billion, up 30 percent from 1994, Cerulli said, and up 50 percent since 1993.

For wrap accounts placed with private money managers, you may need a minimum of $200,000 or more. By contrast, mutual fund wraps often have $50,000 minimums. A few, including several new bank programs, are sold to people with as little as $10,000 to invest. Often, wraps take the form of individual retirement accounts, funded with money rolled over from company pension plans.

What people like most about wrap accounts is that they don't have to think. The broker or planner directs their assets into a mixture of investments -- U.S. stocks, foreign stocks and bonds -- designed to fulfill your investment goals. But this is what brokers are supposed to do anyway. Why pay extra for the wrap?

Furthermore, you can't compare the performance of different brokerage firms' wraps as you can with straight mutual funds. The firms tend to offer standard stock-and-bond portfolios to people who want different levels of risk. But which of the firms does the better job?

Some wrap programs offer 100 or more mutual funds. Others, especially at big brokerage houses or mutual fund groups, limit you to the firm's own funds.

A few brokerage firms offer wraps for self-managed accounts, to people who like to trade their own stocks and trade a lot. You pay a fixed fee no matter how much you buy and sell.

What are your alternatives, if you don't want to pay wrap fees?

If you have a substantial amount of money -- say, $500,000 and up -- you can go to a money manager directly, cutting out the broker and planner. Likely annual cost: around 1 percent.

You can go to a broker or planner for one-time advice on constructing a portfolio of stock and bond funds. Even if you pay a 4.5 percent sales charge, that's cheaper than paying the same broker 1.5 percent a year forever.

You can allocate your own assets among different types of funds, using model portfolios offered free by many no-load mutual fund groups (no-loads carry no upfront sales charges).

Simplest of all, you can allocate your assets among index funds. These funds mimic the performance of various U.S. and international markets and consistently deliver returns that are above average for funds in their group. The Vanguard Group in Valley Forge, Pa., offers the cheapest index funds, and the widest selection.