If you've got half a million dollars lying around, financial advisers have a hot investment product to sell you: a separate account. But it might not be worth the money you pay for it. Long the province of the ultrarich, separate accounts sound exclusive. But as investment minimums have dropped in recent years, so has the level of personalized attention. A separate account is a customized portfolio of stocks and bonds, often set up by one of the major brokerage houses but run by outside money managers. The accounts typically require an investment of $500,000 or even less, down from minimums of $1 million or more as recently as four years ago.
Because they're made up of individual securities, separate accounts claim to offer tax-planning advantages that mutual funds can't provide. That explains much of their appeal to well-heeled investors. "Separate accounts are 'in' and mutual funds are somewhat struggling, at least from a perception standpoint," notes a recent report from Cerulli Associates, a research and consulting firm. Explains Cerulli's Paul Fullerton: "As the high-net-worth demographic grows, more and more people want the tax advantages and customization you can get with separate accounts." Even leading up to the market downturn, growth in separate accounts was outpacing that of mutual funds. In the five years ending in 2000, separate account consultant programs grew at a compound annual rate of 26.1%, well ahead of mutual funds' 18.4%. Granted, accounts are growing from a smaller base, but the interest is still significant. It has helped that some of the nation's biggest brokerage houses, such as Citigroup's Salomon Smith Barney and Merrill Lynch, are pushing the concept, lured by the prospect of fat fees. "The mantra from the higher-ups is to do fee-based business," explains Fullerton. "And the separate-account-consultant wraps also align with the clientele they're going after: high-net-worth investors." investment minimum accounts, now there are accounts with investment minimums of only $200,000. So there are a lot more accounts to deal with," says Scott Leonard, a certified financial planner with Leonard Wealth Management in Manhattan Beach, Calif. Because of his bad experiences with separate accounts, Leonard no longer recommends the products for clients, and sticks mostly to low-cost, tax-advantaged mutual funds instead. "People think when they open separate accounts, the manager is looking at their account on a daily basis and overseeing their personal pot of money. But that's not what happens at all," Leonard says. "Managers have a buy list of stocks, and they go into everybody's account at once and sell IBM and buy Dell." In fact, because separate accounts typically rely on outside money managers, investors don't actually know who's in charge of their portfolios. "You get a generic portfolio of whatever investment objective you fall into," says Michael Boone, a certified financial planner in Bellevue, Wash. In other words, managers may lump clients into "growth" or "growth and income" categories, and therefore treat these investors in the same way. By managing money in-house, Boone's firm essentially competes with separate accounts. But he contends the arrangement works out better for clients because he can tailor investments to their financial and tax situations. A more troubling problem with separate accounts is that they often don't deliver on their promises of tax advantages, which is the reason many investors chose them. In theory, at least, the accounts allow for more careful tax planning than funds because they consist of individual stocks or bonds. Managers are supposed to be able to sell securities at a loss to offset current or future gains. Also, investors aren't buying into pre-existing capital gains. But in practice, managers often don't pay attention to the tax consequences of trading. "We've seen instances where a trade in a separate account took place three days before the short-term capital gain turned into a long-term gain," says Adkins. "A lot of times managers don't track the short-term and long-term differential on capital gains." "There are numerous examples where people utilized this kind of product and the alleged benefits over mutual funds were nonexistent," he says. to a separate-account manager and they've got $10 million and above," says Leonard, "they would definitely be able to demand the attention appropriate for them." The rest of us mortals should think seriously about mutual funds.