In many instances, the type of account arrangement you have with a broker or investment adviser will depend on how much control you want to maintain—or are willing to give up—over the investment choices that are made in your account.
If you establish a discretionary account, you give your investment professional a substantial amount of control. You set the overall direction and goals for the account. The investment professional then executes that strategy by picking individual securities they believe will help you meet your objectives with the appropriate amount of risk. With a discretionary account, managers will not typically seek your permission to buy or sell a particular security. Instead you will see the investment choices they have made, and how those investments are faring, on your monthly account statement and in periodic performance reports.
Discretionary accounts work best for investors who do not want to be actively involved in the day-to-day management of their investments and who want to have a professional manager design a portfolio to meet their financial objectives.
If you’re setting up a discretionary account, you’ll generally fill out an investment questionnaire and meet with your investment professional to identify your financial objectives. This process helps the manager find out whether you are seeking income, growth, or something in between, what your risk tolerance is, whether you are a short-term or long-term investor, and any other special considerations that might affect their choice of investments on your behalf. For example, some investors prefer to invest in socially responsible companies that care about the environment, have good employee relations, and show respect for human rights. These criteria then become one of the many screens a portfolio manager can use when selecting investments for you in a discretionary account.
A professional who works with you on a discretionary basis may develop a customized investment policy statement that outlines the objectives, investment style, expectations, and performance benchmarks for your portfolio. He or she uses this document, along with current information on economic and market conditions, to make and execute investment decisions for your account.
With many discretionary accounts you don’t pay commissions—or in some cases full commissions—on the individual trades the account manager makes for you. Instead, you pay a fee—usually assessed quarterly—that is a percentage of the assets under management. You agree to the amount of this fee upfront, and it is frequently assessed on a sliding scale—the percentage fee often declines the more money you have under management.
With a non-discretionary account, your investment adviser or full-service broker might offer you professional advice in connection with the transactions you execute and may make some investment recommendations. However, your investment professional is not authorized to buy or sell securities for your account without your prior approval. This type of arrangement is best for investors who want to maintain greater control over their investments, but still want the benefit of a broker’s professional guidance.
If you are working with a registered investment adviser and have an advisory account, you typically pay an asset-based charge—say 1-2% of assets in the account per year—in a non-discretionary account. If you are working with a brokerage firm and have a brokerage account, you pay commissions on a per-transaction basis, according to the firm’s regular commission rates. Good customers and large trades may qualify for a reduced commission rate. In addition, discount brokers generally charge less than full-service brokers.