Imagine walking into a clothing store. You have two main choices: you can buy a suit off the rack that fits "most people," or you can visit a tailor to get one measured specifically for your shoulders, your height, and your style.
In the investing world, a Mutual Fund or an ETF is that off-the-rack suit—it’s efficient, popular, and gets the job done. But what if you have a specific tax situation, ethical concerns about certain industries, or a large amount of capital that requires precise handling?
That is where Separately Managed Accounts (SMAs) come in.
Once considered a tool exclusively for the ultra-wealthy, SMAs are becoming increasingly accessible to everyday investors. If you already have a what is a brokerage account, you might be ready to take the next step. This guide will break down exactly what an SMA is, how it differs from a fund, and how to check if the manager running it is trustworthy.
Key Takeaways
- Direct Ownership: Unlike mutual funds where you own shares of a pool, in an SMA you own the individual stocks directly.
- Customization: You can exclude specific companies (like tobacco or competitors to your employer) from your portfolio.
- Tax Efficiency: SMAs allow for "tax-loss harvesting" to lower your tax bill—something mutual funds cannot do as effectively.
- Transparency: You see every single transaction and holding in real-time.
- Due Diligence: Always check a manager’s "Form ADV" on the SEC website before investing.
What Is a Separately Managed Account (SMA)?
To understand an SMA, we first need a clear managed account definition.
A Separately Managed Account is a portfolio of assets (like stocks or bonds) managed by a professional investment firm specifically for you. Unlike a mutual fund, where your money is commingled with thousands of other investors into a single "pot," an SMA keeps your assets separate.
When you invest in a mutual fund, you own shares of the fund. But when you invest in an SMA, you are the direct owner of the underlying securities. If the manager buys Apple stock for your SMA, you are the one listed on the books. This distinction is vital because it grants you the rights of a true asset owner (see what are shareholders and what is stockholders equity).
Typically, an SMA is run by a professional money manager or an asset management firm. You might access these managers through a financial advisor, often distinguishing between different types of financial professionals (learn more about ria vs broker dealer).
How SMAs Work: Transparency and Control
The two biggest complaints investors often have about pooled funds are "I don't know exactly what's in it right now" and "I can't change what's in it." SMAs solve both.
1. Radical Transparency
In a mutual fund, you typically get a report of holdings once a quarter. By the time you read it, the data is months old.
In an SMA, you have total visibility. Because the assets sit in your own account, you can log in and see exactly which stocks you own, the price they were bought at, and the current value. There is no "black box."
2. Precise Control
This is the "tailored suit" aspect. Because the account is separate, you can give the manager specific instructions.
- ESG and Values: Do you want to avoid oil companies, gun manufacturers, or casinos? You can instruct the manager to restrict those specific sectors from your account, without affecting other clients.
- Concentration Risk: Let’s say you work for Amazon and have a lot of company stock options. You might not want your investment portfolio to buy more Amazon stock, because if the company struggles, both your job and your investments suffer. You can tell your SMA manager: "Buy the technology sector, but exclude Amazon."
The Superpower of SMAs: Tax Management
If transparency is the cake, tax management is the icing. This is often the primary reason wealthy investors switch to SMAs.
The Mutual Fund Tax Trap
In a mutual fund, you can get hit with a tax bill even if you didn't sell anything. This happens because of "Capital Gains Distributions." If the fund manager sells a winning stock inside the fund, everyone in the pool shares the tax liability, even if the fund's overall value went down that year. You have zero control over this.
The SMA Solution: Tax-Loss Harvesting
Since you own the stocks directly, you control when they are sold. A smart SMA manager uses a strategy called Tax-Loss Harvesting:
- They identify stocks in your portfolio that have dropped in value.
- They sell those stocks to realize a "loss."
- This loss can be used to offset taxes on your "gains" (profits) from other investments.
- They immediately reinvest the cash into a similar stock to keep your portfolio balanced.
This process can effectively lower your annual tax bill, potentially increasing your after-tax returns without taking on extra risk.
Are SMAs Right for You? (Pros and Cons)
While SMAs offer powerful tools, they aren't for everyone. Here is a balanced look to help you decide.
The Pros
- Customization: Tailor your portfolio to your ethical views or financial constraints.
- Tax Efficiency: Keep more of what you earn by managing when you take capital gains.
- Strategic Focus: Easier to implement specific income strategies, such as a dividend reinvestment plan drip tailored to high-yield sectors.
- Professional Execution: Managers often get better trade execution than retail investors (see principal vs agency trading).
The Cons
- Higher Minimums: While technology is lowering the bar, many SMAs still require minimum investments of $50,000, $100,000, or more.
- Fee Structure: You may pay a "management fee" to the SMA manager plus a fee to your financial advisor. You need to ensure the tax savings outweigh these costs.
- Complexity: For a beginner with $5,000, a simple broad-market ETF is often cheaper and easier to understand.
Conducting Due Diligence for Separately Managed Accounts
If you decide an SMA is right for you, you cannot just pick one blindly. You are hiring a manager to act as a fiduciary for your money. Here is how to check them out using official government tools.
1. Check the "Form ADV"
Every investment advisor registered with the SEC (Securities and Exchange Commission) must file a document called Form ADV.
- Go to the Investment Adviser Public Disclosure (IAPD) website.
- Search for the firm or manager's name.
- Look for "Part 2A" of the form (often called the "Brochure").
This Brochure is written in plain English and contains critical information:
- Fees: Exactly how much do they charge? (Look for "wrap fee" programs).
- Strategies: How do they actually invest?
- Disciplinary Information: Have they ever been in trouble with regulators? (Crucial Step)
2. Verify Performance Claims
Be skeptical of past performance. Ensure the numbers they show you are "net of fees" (meaning the fees have been subtracted). Managers can sometimes present "gross" returns which look higher than what you would actually keep.
3. Understanding the Relationship
When you hire an SMA manager, make sure you understand who holds your money. Usually, a third-party "Custodian" (like Charles Schwab or Fidelity) holds the actual cash and stocks, while the SMA manager only has the authority to trade. Never write a check directly to the manager's personal bank account.
Conclusion
Separately Managed Accounts represent a graduation from "off-the-rack" investing to a tailored financial strategy. They offer the transparency of seeing exactly what you own, the control to align investments with your values, and the tax efficiency to potentially boost your bottom line.
However, they come with higher complexity and often higher minimums. If you are just starting out, low-cost index funds are still a fantastic foundation. But as your wealth grows, the "one-size-fits-all" approach might stop fitting—and that is when an SMA becomes a powerful ally.
Sources
- U.S. Securities and Exchange Commission (SEC) - "Investment Adviser Public Disclosure (IAPD)": https://adviserinfo.sec.gov/
- Investor.gov (SEC) - "Form ADV": https://www.investor.gov/introduction-investing/investing-basics/glossary/form-adv
- Investor.gov (SEC) - "Updated Investor Bulletin: How to Check Out Your Investment Professional": https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-0
- Financial Industry Regulatory Authority (FINRA) - "BrokerCheck": https://brokercheck.finra.org/