The World of Wrap Accounts and Pooled Investments

Lately there has been a huge push by financial institutions to get investors to put money into wrap accounts or pooled accounts. I’ve often wondered how much of this push is in the interest of the investor or whether most of the push comes from selfish motives of the financial institutions. Let’s take a look at some of the benefits marketed by financial institutions.

  1. Efficient Diversification. Wrap account programs are really good at providing efficient diversification by geography, asset, management style, and market capitalization. One of the key benefits of these plans is the ability to put your money into a plan that follows the discipline of proper asset allocation. While the models of asset allocation are not new, it is sometimes difficult for financial advisors and investors to have the discipline to be strict to modern portfolio theory. These programs help to remove emotions and keep investors strict to the discipline.
  2. Automatic Re-balancing. Mathematically, rebalancing a portfolio makes so much sense to enhancing long-term returns and reducing risk. The reality is, so few actually do it. When looking at these Wrap plans, I think automatic re-balancing is one of the biggest benefits. Yet, not all these plans provide automatic rebalancing. In my opinion, I would only consider plans if they have some systematic rebalancing mechanism.
  3. Lower Fees. The area of fees has become quite a sensitive issue in the world of managed money. The fees on various Wrap accounts can vary dramatically from one carrier to another. The reality is that many of these Wrap accounts do not really have lower fees to the investor and many of these plans pay financial advisors a higher trailer commission. Buyers need to be aware. If you are investing in these pooled accounts, ask some tough questions. What are the total fees that will be charged to the investor? If that fee is 2.5% or higher you are not really getting a competitive advantage over other managed investment products like mutual funds. What is the commission earned by the advisor? If the fee is higher than 1.0%, then you might want to ask yourself if the advisor is doing this in your interest or the interest of getting a higher trailing commission.
  4. Best Money Managers. I hear this term far too often in the world of managed money. Is there really such a thing? Having done a lot of research in selecting investments and mutual funds, I believe there is no such thing as perfection and the best and the worst changes all the time depending on the criteria you use and the time frames you look at. Most of the programs out there use managers that are all in house. The cynical view of these plans is that Wrap accounts do not diversify by company. Rather, they bring all the money in house. Some programs have a formalized manager selection process that may or may not be in house. A formal selection process helps to prevent some conflicts of interest and maintain a higher level of objectivity. A program that includes external money managers also enhances some objectivity.Wrap products tend to give you fewer choices of managers rather than more. Hopefully these are the right ones.
  5. Tax Benefits. If you are investing money outside RRSPs, it is not how much money you make but rather how much money you keep that counts. Many of these Wrap plans provide some very significant tax benefits by using a corporate class structure. Take a class structure and add re-balancing and you have a pretty strong one-two punch.
  6. Packaged Investing. With Wrap plans, there are typically a few model portfolios and investors will fill in a questionnaire and get lumped into one of these model plans. They are designed for investors who are looking to delegate to someone else all of the legwork and responsibility of customizing, designing and managing a portfolio.

My two cents

I think the jury is still out on whether these programs really will improve investment portfolio performance. Cynically, I think these programs are an attempt to get more money in house under management using re-balancing and sizzling packaging. Wrap programs may not be too bad but be sure to select ones that offer re-balancing mechanisms, lower fees and some type of manager selection and monitoring process.

I’ve tried to provide an objective look at the benefits promoted by financial institutions. If you dig a little deeper than the surface of the marketing material, you may find some holes in wrap and pooled plans. The bottom line is every investment has pros and cons. Just make sure you are doing it for the right reasons instead of falling into the latest sales pitch.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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