What is a Discretionary Account?
A discretionary account is an investment account where an authorized broker or financial advisor has the authority to buy and sell securities without needing the client’s consent for each transaction. Clients are required to sign a discretionary disclosure that documents their consent.
A discretionary account can also be referred to as a managed account. These accounts often have minimum balance requirements set by brokerage firms and typically come with annual fees based on a percentage of the assets under management (AUM). These fees usually range between 1% and 2% per year.
Key Takeaways
- A discretionary account allows brokers or advisors to manage clients’ trading activities without seeking prior consent for each trade.
- Clients can set personalized investment parameters or restrictions on these accounts based on their preferences or investment philosophy.
- The rise of robo-advisors has introduced automated investment management, offering a low-cost, algorithm-driven alternative for discretionary accounts.
The Inner Workings of Discretionary Accounts
The degree of control a broker holds in a discretionary account can vary, depending on the specific agreement with the client. Clients can set various parameters dictating the scope of allowable investments.
For example, clients might restrict their broker to invest only in blue-chip stocks. Alternatively, an environmentally conscious investor might prohibit investments in tobacco companies. Clients may also stipulate a particular ratio of asset classes, such as stocks to bonds, while allowing brokers the freedom to manage investments within those constraints.
In recent years, robo-advisors have emerged as a popular solution for discretionary account management. These automated advisors use algorithms to manage investments, often employing strategies like modern portfolio theory (MPT). Robo-advised accounts usually have low minimum balance requirements and comparatively low management fees.
Advantages and Disadvantages of Discretionary Accounts
Advantages
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Convenience: Discretionary accounts save clients the time and effort of having to approve each trade.
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Efficiency in Trading: Brokers can execute bulk trades for all clients, ensuring uniform pricing benefits.
Disadvantages
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Higher Fees: Discretionary accounts tend to be more expensive because of the involved advisory and management services.
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Performance Risks: There’s always the risk of underperformance. Studies have shown mixed results regarding the performance of managed asset portfolios.
Setting Up a Discretionary Account
The process to set up a discretionary account usually involves choosing a qualified broker or financial advisor. Many brokerage firms have minimum investment requirements, ranging from a few thousand to several hundred thousand dollars, depending on the level of service and management fees. For example, Fidelity offers varying tiers of managed accounts, with account minimums ranging from zero to $350,000, each providing different levels of service and management fees.
In conclusion, discretionary accounts can be a highly effective tool for investors looking for professional management of their portfolios. It is crucial, however, to weigh the associated benefits against the costs and performance risks.
Related Terms: managed accounts, fiduciary duty, alpha, blue-chip stocks, robo-advisors, portfolio management
