Investment Portfolio Wrap Fees Are Helping The Investment Industry But Not YOU

1% wrap fees on investment accounts
Kevin Wenke

Kevin Wenke

CFP | CLU | Investing | Insurances | Taxes

Our mission here at Decision Tree Financial is to help you make smart financial decisions that are aligned with your values so you can manifest the life you desire. One thing I know for sure is that decision makers hate to get ripped off and instead want to extract MAXIMUM VALUE for the money they spend.

Well…

in my opinion, one of the biggest ruses the investment industry has propagated is the 1% wrap fee charged to investors’ accounts. The amount of wealth that this fee has transferred away from investors and into the coffers of the financial industry makes even Uncle Sam and the IRS jealous because it is so efficient. The industry makes no guarantee in these accounts and even places ALL the risk on the investor, doing an effective “rear-end covering” by having all investors sign disclaimers that state, “Past Performance is No Guarantee of Future Results.”

What is just crazy to me is those who have their money invested in them don’t seem to mind paying the fee because their accounts usually grow over time as a result of the natural growth of the overall market, and they just assume it is the cost of “playing the game.’

Even though the 1% fee represents an average of 10% of a portfolio’s profits (the stock market averages 10% growth, so taking 1% is equal to 10% of the profits), many investors never bat an eye or ask what the advisor is doing to generate these returns because… I don’t know…they have better things to do?

Stock Commissions in Pre and Post Internet Era of Investing

My investment journey began back in February 1996. The first stock two stocks I ever bought were 400 shares of a company called “7th Level” (valued at $2,800 total) and 100 shares of “Astra Pharmaceutical” (valued a $6,800.) To acquire these shares,  I paid my “stockbroker” at JC Bradford in Knoxville, Tennessee, $450 in commissions. I didn’t think anything of it and just wrote the money off as the cost of playing the game…

Prior to the internet, the investment industry was dominated by large financial institutions like JC Bradford, Merrill Lynch, and Bear Sterns, who charged high commission fees to investors wanting to buy or sell shares of stocks. It was the cost to play the game back then…

These high fees helped the investment companies generate millions of dollars of profits over the years while forcing retail investors to pay a large percentage of their investments just to get in on the action. These high fees deterred investors from making short-term investments because it took so long to just break-even. Therefore, once an investor would buy a block of stock, they would tend to hold on to that security for a long period of time. 

This all changed in the 1990s with the proliferation of the internet and the “discount brokerage” model created to exploit it. No longer did an investor have to call a company they wanted to invest in to receive their financial statements or depend on their stockbroker. The information was all found online and could be accessed at the press of a button.

To make it even better for the investor, discount brokerages were charging as little as $5 to buy or sell blocks of up to 5,000 shares of stocks. It didn’t matter if the underlying stock was valued at $300 per share (or $150,000 for the 5,000 share block!) or $0.03 cents! The cost of the trade was just $5!

Compare that to the $450 I paid JC Bradford for my two stock purchases! It is a HUGE cost difference and keeps more money in investors’ pockets! I know when I found out about “$5” commissions, I transferred my account to one of these discount companies, and I never paid more than $5 in my personal account again…

What was good for investors like me was not good for the powerful investment brokerage firms. The discount brokerage model destroyed their profitable business model. So to adapt, they had to pivot and come up with a new strategy. This is how “THE WRAP FEE” was introduced…

What is a "WRAP FEE?"

A wrap fee is a type of commission charged by the new breed of stockbroker called “the investment advisor” for managing a client’s portfolio. 

The wrap fee is a comprehensive charge that covers the total cost of managing a  portfolio. This includes portfolio management, research, trading costs, and other advisory services. The wrap fee is usually priced as a percentage of the assets under management (usually 1%) and is usually charged on a monthly or quarterly basis regardless of how many stocks are bought or sold in that period or how many times the advisor and account owner talk. Once a client transfers their account to an investment advisor, the wrap fee is charged indefinitely and increases (or decreases) as the value of the account changes. 

Decision Tree Financial has a 0.25% fee for our asset allocation portfolio and a standard 1-hour charge for our “Two-Asset” Strategy.

Before the internet, charging clients ‘ongoing commissions” against the value of their account would have been considered scandalous. However, it became a necessity if the large legacy firms were going to continue making the profits they were accustomed to when $5 trading commissions became the norm.

To encourage investors to embrace these new charges, they need to make it seem like a good thing to do. Therefore, they had to come up with a great piece of propaganda that would be easy to understand and impossible to argue with, and they did. They came up with one of the statements ever.

 

Our Success is Linked to YOUR SUCCESS...

People don’t mind paying people when they get what they want. When people invest their money, they want their money to make more money. So, when this  happens, they don’t think twice about the money they needed to pay to make that happen.

When I hear an investment advisor say “Our success is linked to your success because we only make more money when you make more money”, I feel myself start getting a little nauseous.

That is because I know that most investment advisors don’t beat the benchmarks they are measured against and if they do, the additional risk they needed to do that ends up biting them in the ass in later years causing them to lag said benchmark. The averages will always play themselves out…

Even the glorified investor Warren Buffet doesn’t beat the stock market by picking stocks. That is what the industry wants you to believe but the proof is in the performance.

He only beats the market over time by having cash on hand from his insurance companies and using it to “buy low” during times of economic stress when asset prices drop. But he doesn’t always buy stocks when that happens and instead uses financial derivatives that he is quoted as saying are “weapons of mass destruction” as if to deter investors like you from ever using them. The cynic in me believes they want you to feel that way so they can take advantage of you and make money off of your money while doing as little as possible to do it! It is up to you if you believe that too but it is hard to argue the financial industry is a charity out to just help you now isn’t it?

Here is the deal. The stock market is going to flucturate in value no matter what you, me or the person you are paying right now to “watch your money is doing.” 

So, if you are paying a 1% wrap fee for someone to pick stocks and build your portfolio, you are throwing YOUR MONEY down the drain. I am going to suggest you don’t do that and instead do this…

 

The Alternatives to the 1% Wrap Fee...

I have already promoted the fact that we charge only a 0.25% fee on our allocation portfolio. You can use that and we will make sure it is allocated, managed and rebalance correctly as long as you use our services.

If you don’t want to pay us, you can do it yourself too. The truth of the matter is if you use the low-cost index or mutual funds, you can do just as good as we will and keep that fee for yourself. You just have to remember to rebalance your portfolio once in a while, selling a portion of “your winners” and using the proceeds to buy more of “your losers,” which is the purpose of rebalancing.

But if you are like most investors who want the comfort of knowing someone else is looking over your portfolio, I am going to encourage you to learn how we position many of our clients to “Invest Like The House.”

You are probably wondering what I am talking about so let me explain…

A lot of people equate investing in the stock market to gambling in a casino. There are defiantly some similarities. When you do both, you are speculating and putting your money at risk with the hope of making more money. 

Everyone knows that in a casino “The House Alwasy Wins” and that is because they have rigged the odds to their favor…agree?

Well, the wrap fee rigs the odds to favor the investment industry. It doesn’t matter if you make money, or lose money, they are going to get their cut…

Well, you don’t have to play that way. You can use a system that “watches your money” automatically, preventing you from losing too much if the market declines, while also giving you copious amounts of cash to ‘be a buyer when everyone else is selling” just like Warren Buffet does.

Intrigued?

If so, head over to Invest Like The House where I will explain more about what I mean.

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