Managed accounts are perfect for investors who may be uncertain about which securities to choose for their portfolios, how long to hold, how to diversify, and when to sell.
It is because, in a managed account, all decisions are made by an investment manager, like in a mutual fund. In addition, the trader monitors the portfolio continuously to pick up new opportunities.
Similar to a mutual fund, each managed account has a clearly defined style and objective. It is attractive for people who recognize the importance of goal-oriented investment decisions.
Moreover, the official objective also allows investors to identify a benchmark against which to monitor progress toward their goals. That benchmark might be a well-known stock market index, such as the Standard & Poor’s 500-Stock Index (S&P 500). Also, it can be a personalized standard defined with the help of a financial adviser to reflect the investor’s goals. Experts describe this personalized benchmark as a family index.
But while managed accounts and mutual funds share these key features, their differences are more significant than their similarities.
What you own
One critical difference is that if you invest through a managed account, you own the individual securities in your account. The amount you have invested in each security is determined by:
- The total value of your investment
- The number of different securities in the account
- The way the investment manager diversifies your assets
In contrast, if you invest in a mutual fund, you have equity in the total fund portfolio, in proportion to the number of fund shares you own. But you don’t own shares in the individual securities that make up the portfolio.
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Having it your way
One advantage of individual ownership is that your managed account can be customized to achieve better diversification in your overall portfolio or to exclude investments you’d prefer not to own.
For example, if you own your employer’s stock in your retirement savings plan, you and your adviser might decide not to invest additional assets in that company. Or, you may request that certain security you’ve put into the account not be sold.
Although you can probably find funds that invest in a way that’s compatible with your political, social, or religious beliefs, you can’t ask a mutual fund not to buy or sell a particular stock, whatever your reason. What’s more, you may not know which securities the fund owns at any given time. Each fund is required to report its holdings quarterly, but its manager can buy and sell at any time between when one report is issued and the next one is due — and most do.
|Managed accounts||Mutual funds|
|Shares of stock
|Shares of fund
|Managed accounts||Mutual funds|
|• You own shares in individual securities||• You own fund shares not individual securities|
|• You have no phantom gains||• You’re vulnerable to phantom gains|
|• You can time capital gains or losses||• You have no control over capital gains or losses|
|• You can avoid or include certain investments||• You have no influence on the fund portfolio|
|• You always know which investments are in your account||• You learn quarterly what investments the fund owns as of that reporting date|
There are always taxes
One of the few downsides of accumulating wealth is paying income or capital gains taxes on your investment earnings. But investing through a managed account may protect you from some of the unexpected tax consequences of owning mutual funds.
Many mutual fund managers turn over securities in their portfolios regularly, taking profits or cutting losses. Unlike tax-conscious investors, who may wait to sell appreciated assets until the capital gains tax rate, mutual fund managers often sell assets in less than a year. Any short-term capital gains passed on to you are taxed at your regular tax rate.
Further, mutual fund managers are sometimes forced to sell shares if shareholders want to redeem substantial holdings. Any capital gains that result are passed along to you as well, potentially increasing the tax you owe.
You might also have long-term capital gains on the sale of securities that the fund has owned for a long time if they’ve increased significantly in value. Of course, if you’ve been a shareholder for most of the period, you’ve shared the benefits of the growth on which you owe tax. But if you’ve purchased shares only recently, you still owe tax on the gains allocated to your shares even though you didn’t benefit from the security’s increasing value. In fact, the price you paid for your shares reflected that increased value. Those factors produce what is known as embedded or phantom gains, but the taxes they provoke are very real.
With managed accounts, there are no phantom gains. That’s because your cost basis in security is its price the day that security was added to your account. When the security is sold, your gain or loss depends on the difference between the selling price and your cost basis. And if some other investor sells shares in an account run by your investment manager, the transaction has no effect on your account.
Another advantage of managed accounts is that you can ask your investment manager to sell securities that have dropped in value if you can use the capital losses to offset capital gains you’ve realized during the year. Or you can request that any selling be postponed into the next tax year to limit potential capital gains on investments that have increased in value.
Are Managed Accounts Better Than Mutual Funds? by Inna Rosputnia
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