Should You Join the IMA Big Leagues?

Physician's Money Digest, September30 2003, Volume 10, Issue 18

You can't accuse the financial services industry of being dull. Every other day it seems to come up with a new, low-risk product that will make you richer faster. It's rarely at a lower cost, but as long as it makes you wealthier, why care about costs?

Case in point:

Most of these new products are actually old products in new packaging with some cosmetic changes to justify higher costs. Individually managed accounts (IMAs) have been around for a long time, but the large brokerage houses are now aggressively marketing them. They can be big money makers for everyone, except the investor.

Broker Claims

Your broker will explain that putting your money in an IMA is like finally playing in the big league. You get to choose 1 or more money managers from a selected list based on their investment philosophy and track records, who will then custom-design and manage a portfolio of individual stocks and bonds to match your specific financial objectives and situation. In the past, only the very rich had access to such individual money managers. But now you can open an IMA with as little as $100,000 and distinguish yourself from the mutual fund–buying players in the little league.

There are a few claims in favor of IMAs. Apparently, IMAs allow you to choose from a roster of distinguished money managers, many who manage billions of dollars for pension funds, endowments, etc. True, except that the IMA money managers are not any more distinguished than the ones you have access to through mutual funds. Often, they're the same money managers wearing 2 different hats. Money managers with good track records will often manage mutual funds that you can invest in with much less ceremony.

The second claim is that with an IMA, your portfolio will be designed and managed to exactly meet your individual goals, risk tolerance, etc. Once again, there is some merit to this claim, but you can create equally good portfolios matching your objectives and other constraints using low-cost, no-load mutual funds. No great advantage here.

The third claim is, because your account is managed specifically for you, the manager can design your portfolio and time, taking capital gains and losses to minimize your tax bills. But the tax issue is irrelevant for tax-deferred accounts. Even for taxable accounts, the advantage is not all that great. You can minimize tax consequences by buying and holding low-turnover funds.

Actual Issues

Most people shouldn't rush into the big league of IMAs. It's nearly impossible to choose investment managers who will perform well in the future. Even with all the data available for mutual funds, no one seems to have developed a reliable method to predict which managers will do well in the future. In the case of IMAs, there is much less data available. The scant evidence you can locate shows that IMAs do not perform any better than mutual funds.

Your broker will insist their firm's research department has chosen its roster of money managers after extensive analysis. You can't go wrong with any of them; all you have to do is pick the manager whose investment philosophy you are most comfortable with. Proceed with caution: Brokers push IMAs because they're highly profitable. The average annual fee for an IMA is around 2% per year, and often the transaction costs are additional. These fees don't compare favorably with the average expense ratio for mutual funds of around 1.5% per year. You can buy index funds and even good actively managed funds with fees between 0.25% and 0.75% per year.

If you don't think you know enough to manage your money on your own using mutual funds, your best bet is to find a competent, fees-only investment advisor to manage your portfolio using mutual funds. Aim for a combined investment advisory fee and total fund cost of around 1%.

Chandan Sengupta, author of The Only Proven Road to Investment Success (John Wiley; 2002), currently teaches finance at the Fordham University Graduate School of Business and consults with individuals on financial planning and investment management. He welcomes questions or comments at chandansen@aol.com.