What Is a Wrap Fee?

What Is a Wrap Fee?

Let me explain what a wrap fee really is. It's an all-inclusive charge that investment managers or advisors levy for their services, covering things like investment advice, research, brokerage, and administrative fees. This fee is calculated based on the assets in your account, usually ranging from 1% to 3% per year of the assets under management.

What makes a wrap fee appealing is how it simplifies your investing costs and makes them predictable. If you're an active investor who frequently needs the full range of services from your advisor, this could be a solid choice. But if you're someone who builds a portfolio and holds it long-term without much tinkering, it might not be the best fit, as you could end up paying for services you don't use.

When you're considering a wrap fee, always dig into the details. Ask exactly what's included and what's not, because every firm designs its own program, and some are more comprehensive than others.

Important Note on Disclosure

Remember, investment advisors are required to provide you with a wrap fee brochure that lists exactly what services are included in the fee. This is a key piece of transparency you should insist on reviewing.

Understanding Wrap Fees

The main advantage of a wrap fee is its predictability—you know upfront what you'll pay for the year, regardless of how much you use the advisor's services. Firms must give you a brochure outlining what's covered and any potential exclusions.

If you plan to use your broker's full suite of services, a wrap fee makes sense because it bundles all those direct costs. This includes commissions, trading fees, advising fees, and even some administrative expenses of the firm.

You need to weigh if the 1% to 3% fee is worth it based on the services you actually use. If you're a hands-off investor with a stable portfolio that rides out market fluctuations, paying individual fees for occasional changes might be cheaper.

Special Considerations

Wrap fee programs go by various names, such as asset allocation programs, investment management programs, asset management programs, separately managed accounts, or mini-accounts. No matter the label, they fall under Rule 204-3(f) of the Investment Advisers Act of 1940, which defines them as programs charging a specified fee not based directly on transactions for advisory services and transaction execution.

In December 2017, the SEC issued an investor bulletin with basic info on these programs and questions to ask your advisor before signing up. It's worth checking that out if you're considering one.

Advantages and Disadvantages of Wrap Fees

On the plus side, wrap fees give you predictability—you know your costs in advance, no matter your level of engagement with the advisor. They also eliminate the incentive for brokers to churn trades just to rack up commissions.

However, the drawback is that you might pay for services you don't need. If you're a passive investor, that 1% to 3% could eat into your returns without much benefit, especially if your portfolio is in low-maintenance assets like ETFs. In those cases, a pay-as-you-go approach might save you money.

Keep in mind that fees in general can erode your investment returns. Wrap fees, at 1% to 3% of assets under management, can be steep for smaller accounts. You might still face additional costs, like mutual fund expense ratios. If you can't afford it or prefer a buy-and-hold strategy, sticking with individual investments could be better.

What Is a Reasonable Wrap Fee?

A typical wrap fee falls between 1% and 3% per year of assets under management, but reasonableness depends on what's included. SEC rules require advisors to provide a brochure specifying services and charges covered.

You might still pay extra for things like mutual fund fees or third-party charges. Even some brokerage fees could be outside the wrap, so review everything carefully.

Is a Wrap Fee Worth It?

It comes down to how much you rely on your advisor and how often. If you trust their management and don't second-guess decisions frequently, you might not need the wrap fee's coverage.

The fee bundles professional advice, research, trading fees, and admin costs. If you don't use them much, opt for pay-per-use to avoid overpaying.

How Is a Wrap Fee Calculated?

Each firm sets its own wrap fee structure, so terms vary. Fortunately, they must provide a brochure detailing covered services.

I suggest asking your advisor directly if a wrap fee or per-use fees suit you better, and why—that can clarify your decision.