What is a discretionary account?
A discretionary account is an investment account that allows an authorized dealer to buy and sell securities without the client’s consent for each transaction. The client must sign a discretionary disclosure with the broker as documentation of the client’s consent. A discretionary account is sometimes called a managed account; many brokerages require a minimum of customers (such as $ 250,000) to be eligible for this service, and generally pay between 1% and 2% per year of assets under management (AUM) in fees.
Understanding discretionary accounts
Depending on the specific agreement between the investor and the broker, the broker can have varying degrees of latitude with a discretionary account. The customer can define parameters concerning the negotiation of the account.
For example, a client can only authorize investments in blue chip stocks. An investor who favors socially responsible investment can prohibit the broker from investing in tobacco company stocks or in companies with poor environmental results. An investor can ask the broker to maintain a specific equity / bond ratio but leave him the freedom to invest in these asset classes as the broker wishes. A broker managing a discretionary account is responsible for the express instructions and constraints (if any) set out by the client.
A new type of discretionary account comes from robo-advisers – automated investment management services performed by algorithms with minimal human intervention. Robo-advisers generally follow passive indexed strategies that follow modern portfolio theory (MPT), but can also be used with user-defined limitations, such as socially responsible investing or following a specific investment strategy of their choice. . Unlike traditional managed accounts, robotic advisory accounts require very low minimum account balances (such as $ 5 or even $ 1) and charge very low fees (0.25% per year, or even no fees).
Advantages and disadvantages of discretionary accounts
The first advantage of a discretionary account is convenience. Assuming that the client trusts the broker’s advice, the ability for the broker to execute transactions at will saves him time to communicate with the broker before each potential transaction. For a client who trusts his broker but hesitates to hand over the reins in full, this is where the definition of parameters and directives comes into play.
Most brokers process transactions for a multitude of clients. Occasionally, the broker becomes aware of a specific buying or selling opportunity that is beneficial to all of his clients. If the broker must contact clients one at a time before executing the transaction, trading activity for the first clients could affect the price for the clients at the end of the list. With discretionary accounts, the broker can execute a big block transaction for all clients, so that all of his clients receive the same price.
Handing over your account trading to a portfolio manager has its own set of risks. The first concerns costs. Typically, discretionary accounts are more expensive than non-discretionary accounts because they use the services of a manager to manage your transactions and manage risk. Fund managers and advisers are bound by fiduciary rules that require them to act in the best interests of their clients. They charge fees on a quarterly or annual basis.
The second risk concerns performance. A 2020 study by Asset Risk Consultant (Arc) found that around 50% of asset portfolios had underperformed the market and generated negative returns. Only 20% had positive returns, called alpha, while the rest were market neutral.
Key points to remember
- A discretionary account is an account in which clients cede control of their trading account to brokers or advisers, who select and execute transactions for them.
- Customers can customize these accounts by specifying restrictions or preferences for investing the style or themes. In recent times, robo-advisers have also become popular instruments for discretionary accounts.
- The benefits of discretionary accounts include rapid transaction execution and expert services. The disadvantages of discretionary accounts include higher fees and the possibility of negative performance.
Discretionary account setup
The first step to opening a discretionary account is to find a registered broker who offers this service. Depending on the brokerage, a minimum account may be required to open a discretionary account. For example, Fidelity offers three levels of managed accounts, one with a minimum investment of $ 50,000 and each of the other two requiring a minimum of $ 200,000. Managed account levels with higher minimums offer wider service menus and lower management fees.