Investment Consult

Should a team manage your portfolio?

You may want to consider these brokerage-house alternatives to mutual funds.

Lewis J. Altfest, PhD, CFA, CFP

Many times in this column, I've touted the benefits of using mutual funds to invest in the stock market. Funds allow you to gain broad market exposure or to diversify by market sector or type of company (large-cap and small-cap, growth and value). They employ managers and analysts to do your homework for you. And because the minimum investment for many funds is as little as $1,000, they're especially good for young physicians who don't have a lot of cash.

But a fund company's investor relations department won't provide all the guidance you need to effectively manage your money. More often than not, the staff will provide information but not advice. And although a broker or financial planner can evaluate investments, make recommendations, and answer your questions, he or she can't be an expert in every area of the market.

What's the solution? One possibility worth considering is a privately managed subaccount. A brokerage firm sets up and oversees it, often as a "wrap account" that bundles management fees and commissions included in a single annual charge of around 2 percent. Subaccounts have always been popular with the extremely wealthy. But I'm finding that the concept is also growing fast among those with $1 million or so to invest. Let's look at some of the reasons why.

More experts. The investing is done by a team of submanagers, each of whom has specialized knowledge in a single area such as bonds, international stocks, small-caps, and technology. Your lead broker will quarterback your team, and track and review your overall progress.

Flexibility. You can work with your broker and submanagers to avoid including in your portfolio investments you find objectionable—stocks of tobacco companies, say.

Unbiased advice. Because wrap programs compensate your advisers with a fixed percentage of assets, your broker and submanagers won't be tempted to favor one type of investment over another. Nor will they have an incentive to buy and sell excessively within your account, a practice known as churning.

Tax advantages. A mutual fund's capital gains are taxable to you even if the fund has had a negative return since you bought your shares, and even though some of the stocks sold may have been purchased years before you added the fund to your portfolio. The basis for gains or losses on stocks held in brokerage accounts, on the other hand, is their value on the date the brokerage house invests your money. Moreover, in a subaccount, selling can be tailored to your tax needs; the manager could cash in some winners to offset losses elsewhere in your portfolio, for instance.

Lower costs. Many actively managed (nonindex) mutual funds charge more than 2 percent a year in expenses, including marketing costs. If other investors sell shares and assets shrivel, you'll be left to shoulder a bigger portion of the fund's costs. On a wrap account, you pay a fixed annual percentage—between 1 and 3 percent of the value of your assets. Generally, rates are lower for larger accounts, so look carefully at the firm's rate structure. If you can save half a percentage point on, say, a $1 million account, you'll save $5,000 in the first year alone.

Of course, subaccounts have some disadvantages. First, the promise of individual attention can be more smoke than substance, especially in small accounts. A computer program may select stocks, with scant direction from analysts.

Second, and perhaps more important, is the difficulty of "firing" a submanager who consistently underperforms. Besides the obvious emotional aspects if you've worked with this person face to face, you could be left holding a hefty tax bill if you can't find a new manager and must liquidate a subaccount.

Finally, even though subaccounts can help diversify your portfolio, many investment firms won't assign less than $100,000 to each submanager. You can better hedge your bets by purchasing core mutual funds that cover broad investment categories, including those that specialize in real estate and international stocks.

The author, a fee-only financial planner, is president of L.J. Altfest & Co.(www.altfest.com ), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

 

Lewis Altfest. Investment Consult: Should a team manage your portfolio?. Medical Economics 2002;4:16.