Wraps and why advisers love them

What is a wrap account?

A wrap account (or platform) allows you to purchase listed securities (both individual shares and ETFs), as well as unlisted managed funds (including those with high minimums that would otherwise make them inaccessible for most people), and all through a single account. They also have consolidated reporting, making the administration of complicated investment portfolio’s much simpler. Wraps also allow you to authorise an adviser to manage your portfolio on your behalf.

Whether to use a wrap platform comes down to 4 questions

  1. Do you need a complicated portfolio?
  2. Do you need unlisted funds?
  3. Do you need an adviser to manage your portfolio?
  4. Do you need consolidated reporting, and at what cost?

Do you need a complicated portfolio?

If you know what index funds are, you will know that a complicated portfolio provides no advantages, but a host of disadvantages.

Many advisers try to convince you to use platforms based on the idea that they can outperform the market for you with their active management. If people whose entire career is based around analysing companies that outperform the stock market cannot beat the index, how successful do you think a financial adviser is going to be when analysing companies is a tiny part of their job, which includes goal setting, budgeting & cash flow management, debt management, savings goals, retirement funding, superannuation, tax, insurance, and estate planning?

But what about a financial planner having more skill in identifying fund managers that will outperform? Nope, this is just another sales pitch. They pick fund managers with a good track record, but SPIVA reports show that out of the funds that outperformed the index over 5 years, 74.8% failed to outperform the market in the following 5 years.

Hopefully by now it’s clear that neither actively managed funds, nor advisers building complicated portfolios by picking actively managed funds, are going to be a winning bet without a lot of luck. In fact, you’ll need luck even to match a simple index-based portfolio.

To answer the first question Do you need a complicated portfolio? the answer is — absolutely not. In fact, it’s more likely to lead to a worse outcome.

Do you need unlisted funds?

In this article on other asset classes, I went through unlisted property and unlisted infrastructure, explaining that unlisted assets are generally illiquid and difficult to buy and sell, are not subject to any listing rules or ASICs ongoing market supervision, are hard to accurately price without market pricing, and their information is intentionally hard to find, so you need to be an expert to know how to pick the sales and marketing from what you’re really likely to get.

Investing in unlisted real estate funds incurs due diligence, high management expenses, high transaction costs, multi-year periods of locking up capital, and a lack of transparency on current asset values given lagged valuations. In fact, many advisers avoid unlisted funds as a result of these problems.

In addition, listed property and infrastructure funds are readily available without the need for a wrap platform. So in answer to the question — you certainly don’t need unlisted funds.

Do you need an adviser to manage your portfolio?

Let’s first distinguish between setting up and managing a portfolio.

Setting up a portfolio of index funds involves a systematic process of:

  1. Determining your risk tolerance
  2. Determining your ratio of Australian to international stocks
  3. Determining your ratio of AUD-based assets to non-AUD-based assets.

I’ve gone through these in some detail in the first section of this website under Building A Passive Portfolio, but I can see a potential use for a good adviser to assist in initially setting up a portfolio, particularly with determining your risk tolerance.

That’s it for setting up. Once you’ve determined your risk tolerance, Australian to international stock ratio, and the currency ratio within your portfolio, these translate directly to a simple 1-5 fund portfolio of low-cost index funds.

What about managing the portfolio?

Managing an index-based portfolio takes minutes a year. Yes, you read that right.
When cash is available to invest, open your investment spreadsheet which shows which fund is most below the target, log into the brokerage account, make a purchase. Done.

There are many advisers that sell themselves on being able to help you remain invested by “talking you down” when you panic and want to sell everything in a severe market downturn, but there are plenty of stories where this failed to happen. It’s often just a sales pitch to convince you to continue paying them thousands of dollars a year. I’ve met people who went to their adviser during the GFC to sell everything and move to cash, and the adviser did it without a word. Other times the adviser tried to talk the client down, but they never educated the client about the nature of the stock market and the client’s fears made it impossible to be talked out of. Your best way forward is self-education — to understand the volatile nature of the stock market and that remaining invested in tough times is the way you earn the higher return of growth assets.

To wrap up the last question Do you need an adviser to manage your portfolio? the answer is a resounding no. Although, the initial setup may be useful. After that, managing a passive index-based portfolio requires very little work. You can easily manage it yourself through a broker which is much cheaper than a wrap account, and they don’t charge ongoing fees or offer financial advisers a way to set up automated payments to themselves from your portfolio each month. Yes, you read that right, and we will get to that next.

Money and motivation

Flat fee-for-service vs ongoing fees

Quoting directly from the final report of the royal commission into misconduct in the financial services industry:

Unlike many other service industries that operate on a fee-for-service model, much of the financial advice industry did not choose to structure its fee arrangements on the basis that a client would pay a fixed fee or an hourly fee for the time spent by an adviser in preparing advice for the client. Rather, in what appears to have been an attempt to replicate the revenue stream that flowed from a combination of upfront and trail commissions, many advisers charged an upfront fee for preparation of a statement of advice, and encouraged clients to enter into an ‘ongoing fee arrangement’, under which the adviser would charge an ongoing fee in exchange for particular services.
Of course, unlike a trail commission, which is paid by the product issuer in recognition of the initial sale of the financial product, an ongoing fee is paid by the client, and is paid in exchange for the provision of a service. This shift – from a model that imposed no ongoing obligations on a financial adviser to a model that did impose such obligations – lies at the heart of the ‘fees for no service’ matter

Can you think of a better way to get money out of people than to charge ongoing fees regardless of what services actually end up being used?

The financial advice industry can..

Fees are extracted seamlessly in the background for the platform fee — and for your adviser fee

The platform takes their ongoing fee seamlessly before your money gets to you so that you don’t notice the money leaving your account regularly.

Additionally, they allow advisers to charge clients the same way within the platform so that you don’t notice your ongoing adviser fee leaving your account month after month, year after year, and don’t realise what your investments would have returned without those ongoing fees eating away at your nest egg. This is fantastic for the adviser. Not so much for you.

In case you haven’t made the connection, this is why most advisers LOVE platforms.

Let me be clear about what I mean by advisers taking their ongoing fee ‘seamlessly’, ‘in the background’, and ‘out of the client’s attention’. I don’t mean they take money without consent. I mean once the client has agreed, it becomes an automated ongoing expense. It becomes part of your fixed living expenses — those expenses that you just assume are necessary to exist and run your life and can not be cut out, like rent, mortgage, phone, internet, insurance, etc. Psychologically, automated ongoing expenses become a normal expense in your mind and the adviser has successfully secured an income stream from you, knowing that it’s human nature to continue doing what you currently do rather than to overcome inertia and make a change. Especially when it gets taken from an account you seldom look at and without you doing anything to initiate each payment or being notified when it happens.

Ongoing fees — the monster that eats from every paycheck before you get it

I read a book by a financial adviser who described the fixed expenses part of your spending as monsters that sit there eating away at your income before it even gets to you. He pointed out that your available money to use for achieving your lifestyle goals is not your gross income less tax, but rather your gross income less tax and less ongoing fixed expenses. Ongoing platform and adviser fees sit there eating away at your investment in the background month after month, year after year, leaving you with less money to use in retirement.

Advisers can charge you percentage-based fees instead of fixed fees through platforms

Not only can advisers charge you fees that are extracted seamlessly through a platform, but they can charge you a fee based on the total value of your assets invested (known as Assets Under Management or AUM). Over time you expect your assets to grow, yet the amount of work for an adviser to manage a 300k portfolio or a 3 million dollar portfolio is exactly the same, but with an AUM-based fee, they can get 10x the fee from you each year. ASIC banned commissions to advisers on products, but ongoing AUM-based fees are essentially commissions in disguise and are a legal loophole for advisers — and platforms are what enables advisers to get these ongoing AUM-based fees.

Many platforms don’t even allow investors to control their own money and require an adviser to make the purchases

What is shocking to me are those platforms that flat out disallow investors to control their own investments. The client either has to liquidate their entire portfolio (and realise capital gains from potentially years or decades) or find another adviser that they will have to continue paying the ongoing fees to each year. It’s beyond me how ASIC allows this.

In summary

Many advisers team up with wrap platforms to feed off clients. The adviser convinces the client that they can outperform (despite the overwhelming evidence against it), they frequently put clients in a dozen or more funds to make it seem like investing is so complicated that the client feels like they have no other option but to pay the adviser to manage it forever. They have a way to get paid ongoing AUM-based fees, and they get paid seamlessly so that the fees eat away at the investment returns in the background out of the client’s attention without the client seeing a comparison of what their investment would have been without those fees. And if the client ever wants to leave, they are dissuaded by the wrap platform requiring them to realise years of capital gains or to find another adviser to continue paying ongoing fees to. The whole thing is the kind of racket that the mob would dream up.

How much would something like this setup end up costing you in retirement?

I recently listened to a podcast where two financial advisers were talking about wrap platforms. After not too long, one of them said that once you include the cost of the platform, the investment fee, and the adviser fee, it doesn’t even come to 1%, implying that 1% wasn’t much money.

Let’s take a look at the effect of those not even 1% fees after 40 years of compounding on a $100,000 investment with 6% after-inflation returns (which is the historical average)

The first with 1% management fees taken out. The second at 0.2% management fees of index funds taken out.

$100,000 for 40 years at 5% compounded annually = $703,999
$100,000 for 40 years at 5.8% compounded annually = $953,732

Those not even 1% fees cost you over a quarter of your net worth.

And for those that know about the 4% rule — paying 1% of your capital per year in fees leaves you with a quarter less to live off. It’s the difference between drawing down $30,000 p.a. vs $40,000 p.a. from a million dollar portfolio in retirement.

When it comes to fund management fees, 1% is an enormous amount.

It’s impossible for a financial adviser not to know exactly how much this will cost your nest egg. So when an adviser makes a comment suggesting that 1% or 2% isn’t much, you can be certain they’re not working in your best interest, they’re working for their best interest at your detriment.

If there is one thing I want you to take from this article, it is that ongoing fees compound to astronomical amounts of lost money. After this article was written, I was compelled to wrote a whole article making it crystal clear how exactly 1% fees cost you so much.

And what’s more, you don’t need to pay these ongoing fees. There are advisers who, by default, put you into index funds and help you set up your own brokerage account and show you how to make the purchases yourself, and don’t try to push you into ongoing yearly advice fees. They are rare, but they do exist. In fact, one of the most important questions you can ask an adviser in the initial interview is what their investment philosophy is. If they try to sell you on their superior investments, run. If they say passive investing, you still need to pay close attention to suggestions of ongoing fees with a critical eye — how exactly are they earning this ongoing fee and should it really be in the thousands of dollars every year? Or is the ongoing fee a sales pitch to line their pockets with your money for possible services that may never be used.

The names of the different products advisers try to get you into for their ‘special’ managed portfolios include:

  • Wrap Account
  • Master Trust
  • Investor Directed Portfolio Service (IDPS)
  • Separately Managed Account (SMA)
  • Individually Managed Account (IMA)
  • Managed Discretionary Account (MDA)

Do you need consolidated reporting, and at what cost?

Consolidated reporting is one of the most commonly cited reasons by advisers in convincing their clients to use platforms.

However, if you are using broad market index funds which are available as ETFs, using a low-cost online broker instead of a wrap platform will:

  • eliminate ongoing platform fees entirely
  • result in very low brokerage fees, some as low as $0
  • provide you with CHESS sponsorship
  • give you something even better than consolidated reoprting — MyGov Prefil where your tax liabilty is automatically populated for you when doing your tax.

So if you are interested in broad market index funds, the consolidated reporting is of no value. In fact, if your adviser has agreed to put you into low-cost index funds and is suggesting a platform, they should provide a compelling reason.

Unfortunately, since advisers can not charge ongoing fees through online brokers, they seldom recommend them.

More often than not, consolidated tax reporting is used as a sales pitch for advisers wanting to get clients into platforms so they can charge their high ongoing fees in an automated way through the platform.

Financial advisers have what is called a “best interest duty”, which means they must be able to demonstrate to ASIC (if asked), how a recommendation to a client was in the client’s best interest. To get around this, they often recommend wraps, arguing that it can save on accountant fees. But in reality, it’d be cheaper to use an accountant instead of paying thousands of dollars a year in ongoing AUM-based fees.

One of endless examples — I recently asked someone on a personal investing forum who uses a wrap account what they couldn’t invest in through a brokerage account, and they said there were none. When I followed up asking why they went with the wrap platform, they said because their adviser said it provided easier tax reporting. When they want to move away from the ongoing fees, this person needs to pay $100 per holding to do an in-specie transfer out of the platform. And in true adviser style, they were put in 21 different funds to make it seem too complicated to manage as a way to ensure they continue feeding off the client indefinitely (complexity to an adviser is job security). As a result, there is a $2100 transfer fee to get out of the platform due to having so many holdings. I can’t even count how many times almost identical versions of this story have been told to me.

Wrap platforms in super

Unfortunately, despite the efforts of the government to encourage people to use superannuation, the super industry has major problems, with many funds charging high fees, limited options, and the worst is the lack of transparency.

Many advisers state this as the reason for using wraps in super. Let’s take a look at whether that’s really the case or whether it’s just another reason to use wraps so that they can team up together to feed off the client.

Limited options in regular super funds

Yep, investment options are more limited in super. However, as explained above, you don’t need complex investment options. Many super funds have low-cost broad market index options allowing you to set your own ratio of Australian to international index funds and your ratio of stocks to bond index funds. HostPlus, SunSuper, QSuper, Rest, even Colonial First State have low-cost index options. These are just a few off the top of my head.

But these options have a tax disadvantage to direct investing with wrap platforms

They do, and I even discussed it in this article on the problem with pooled funds. In there, I mention that there are 3 ways to avoid this problem – direct investment options in super funds, wrap platforms, and an SMSF.

At high balances, SMSF with low-cost providers win out due to the fixed costs and no percentage based fees.

At low balances, wraps are cheaper than SMSFs, but do you know what’s even cheaper than wrap platforms and offers the exact same way to alleviate the tax disadvantage? Direct investment options in super.

With Wraps, you can have consolidated reporting for all of your finances both inside and outside super

For simple index-based portfolio’s, I still can’t see a case for platforms. How hard is it really to track 1-5 funds outside super and 1-5 funds inside super?
But if you’re looking at a platform where the total fee is very low, I can see a case for a little more convenience. If Vanguard’s super (set to come out next year) allows an index fund based portfolio both in and out of super, I can see a case for that. At the costs of other wrap accounts, it’s a hard pass.

To summarise:
— Yes, there are limited options in industry super funds. Does it matter? No. Indexing is superior the overwhelming majority of the time, and many industry super funds offer great low-cost index options.
— Is the cost worth it? No. What about when you factor in the tax advantages? Again, no — at lower balances, industry super funds still win out, and at higher balances, direct investment options are cheaper and accomplish the same thing.

Final thoughts

The case for a wrap account (platform) is when you believe that either you or your adviser:

  • Can outperform a simple index-based portfolio.
  • Have the know-how to analyse unlisted funds for their management, the investments they hold, and the many layers of fees.
  • Have the willingness to take on the additional set of risks inherent in unlisted funds.
  • Would like comprehensive reporting (for using unlisted funds).

There are certainly some who can outperform the market or who can analyse unlisted funds in-depth and are willing to take on the additional risks, and if you are one of those rare people, a wrap platform could be very useful. However, assuming that your adviser happens to fall in this small percentage of people that can outperform is not a bet I would make.

Financial planners love wrap platforms because it allows them to charge their ongoing, AUM-based fee seamlessly in the background out of your attention, which will be a massive drag on returns over time (but a fantastic way to generate ongoing income for themselves). If you go with a financial planner, look for an adviser that offers a fee-for-service model.

If their default advice is to use a wrap platform, take a close look at how much they’re charging you for their ongoing fees and ask yourself if they are really worth thousands of dollars every single year, adding up to a quarter of your nest egg when the majority of their work is done upfront. Remember, just because they framed it to sound like it’s normal to pay an ongoing fee of thousands of dollars every year, doesn’t mean you have to accept it. You’re in the drivers seat, and you can choose if you don’t want to pay ongoing service fees after their initial service has been provided. You can still have a check-up when your circumstances change and ask them to specify what changes to your plan (if any) they suggest, and consider whether the cost of an amendment or a new plan is justified.