Private Money Managers vs. Mutual Funds

by Alan Lavine and Gail Liberman

Are you better off having a professionally managed investment account or investing in a mutual fund?

Some say that as competition is pushing down fees, managed accounts--sometimes known as "wrap accounts"--may be getting more attractive. 

With a managed account, you hire a money manager to handle your stock, bond and/or mutual fund investments. The fee averages about 2.25 percent annually. You generally don't have to pay brokerage commissions when the manager buys or sells securities.

Most managed accounts require $100,000 to $250,000 initial investment.

By contrast, you can invest as little as $1,000 in a mutual fund. Mutual funds can be low-cost. No-load funds charge no commissions. And if you stick with a fund group such as Vanguard, it can cost as little as .30 percent in annual expenses to invest in a stock mutual fund.

However, a new wave of managed account programs springing up claim to blend the best of both worlds--lower fees and minimums, with more individualized management.

With managed accounts, the money manager buys stocks and/or bonds based on your particular financial situation.  RunMoney.com, San Diego, an online money management service, for example, lets you place restrictions on securities that you don't want to own. Also, it can make some adjustments on your individual stocks around the end of the year for tax purposes.

Mutual funds typically can't do that. They are pooled accounts. Everybody's money goes in the same stocks and/or bonds. A chief advantage of a managed account is your financial adviser may have more control of your tax situation. He or she can invest in municipal bonds for tax-free income, for example, and take profits on stocks and offset them with losses on other stocks.

Mutual funds, on the other hand, are required to distribute all realized profits by year end. So you could find yourself getting a whopping capital gains tax distribution even though your fund's net asset value declined!

Another downside of mutual funds: Money flows in when a fund is hot, and the fund manager is forced to invest in stocks at higher prices. But when the fund does poorly, investors can leave in droves. The fund manager is forced to sell stocks to meet redemptions when he or she would rather be investing in cheaper stocks. Plus, as your fellow shareholders jump ship, your share of the fund's capital gains rises!

There are several tax-managed mutual funds, though, that strive to limit taxable distributions. Take the Vanguard Tax-Managed Growth and Income Fund. If you're in the highest 39.6 percent tax bracket, for example, the after-tax return on that fund over the past three years has run about 97 percent of the pre-tax return, according to Morningstar Inc., Chicago. This compares with the average large company stock fund's after-tax return of 89 percent of the pre-tax return.

If you consider a professionally managed account, keep in mind that there is no guarantee the managed account will outperform the stock market or common stock mutual funds.  Also, there is no centralized source that tracks the performance of money managers. 

You can track mutual fund performance daily in the newspaper. You also can go to www.Morningstar.com to check on a fund's performance.

Arthur Siddon, spokesperson for the non-profit Forum for Investor Advice, Bethesda, Md., suggests taking these steps if you are going to hire a private money manager. 

* Make sure the manager's investment philosophy and goals are in sync with yours. If you are a conservative investor, you don't want someone chasing after hot Internet and technology stocks.

* Ask to see a statement of the manager's investment performance, audited by a certified public accountant. Look to see how the manager did in both up and down markets. Check performance this year in a flat stock market. Examine performance in 1990 and 1994--when the markets were off.

* Ask to see the adviser's "ADV form," detailing background information. Advisers who manage more than $25 million in assets are required to file this form with the Securities and Exchange Commission (www.sec.gov). 

* Check with state and federal regulatory agencies to see if there has been any disciplinary action against the manager. If you are considering a broker, you can check with www.nasdr.com or call 800-289-9999. 

* Ask for referrals.

"Always be careful about people with outlandish claims," Siddon says. "If a money manager touts astronomical returns, you have to be careful. If it sounds to good to be true, it usually is."

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.