What are discretionary accounts?
Discretionary accounts allow an authorized broker to buy or sell securities without getting the client’s consent. In general, discretion means freedom to act or decide freely in a particular situation. The same logic is the same for these accounts as their name suggests. However, the client needs to sign a discretionary disclosure with the broker. Hence, there is a written document or proof he consents to the agreement.
Other people refer to these accounts as managed accounts. Several brokerage firms will ask a minimum requirement from a client to avail of this kind of service. The usual payment is around one to two percent annually of assets under management in fees. Agreements between clients and brokers are not the same. So, the broker’s latitude with one discretionary account may be different from another. The client has the right to set parameters and limitations regarding the account trades.
Let us cite an example.
Let us say that you are the client and you have a discretionary account with your broker. In your agreement, you only allow him to make investments in specific stocks. Let us say that you are an advocate for the environment. You may instruct the broker to only invest in stocks that do not harm the environment. You can also make other instructions. For instance, you can tell your broker to maintain a certain ratio for your stocks and bonds while allowing him to invest in asset classes of these kinds if it is suitable for the situation. The broker needs to accept all the instructions and prohibitions of the client.
Did you know that we already have Robo advisers that make discretionary accounts? This refers to automated investment management services made possible by algorithms with almost no human intervention. Robo advisers will most likely follow passive indexed strategies following the Modern Portfolio theory. Others also use user-instructed limitations like those that invest socially responsibly or follow the preferred strategy. They only ask for minimum account balances, unlike the typically managed accounts that we know. And when we say minimal balance, it can be as small as five, three, or even a single dollar. It does not end there because they only charge 0.25 percent every year. Some do not even charge.
Why discretionary accounts?
We can’t deny that these accounts come with convenience and ease. But the client must make sure that the broker is trustworthy to give him latitude to place trades at his discretion. This will save both of their time since the broker does not need to get the client’s consent when he wants to do something for the account. However, some people cannot fully trust brokers, no matter how excellent their reputation might be. It is quite understandable since we are talking about money, and we want to earn more and not lose them in the long run. So, the client has the right to establish parameters and guidelines.
Brokers, especially those who already have a lot of experience, already know specific buying and selling opportunities to help clients. But if one broker needs to ask their clients one by one and every time he wants to place a trade, this activity for the first few clients will affect the pricing for those at the latter of the list. This is not a problem for discretionary accounts because the broker can simply place a large block trade for every client at once. Hence the pricing is fair and the same for all clients.