Investor Basics: Account Types and Terminology
In financial services, many terms relating to different types of accounts and financial products are bandied about, but what do they mean? Here is a brief primer on some account types and other terms you might see.
Basically, any fee for service or other expense associated with an account. These may include traditional trading commissions, account maintenance fees or annual fees. Many financial service firms will offer fee waivers based on attaining minimum levels of activity or assets, so check with your provider.
A traditional brokerage account is simply an account at a brokerage firm that allows you to trade stocks, bonds or other securities. Full-service accounts involve trading through a live broker, who often have a relationship with the client built over time. Investors could also allow the broker trading discretion (a discretionary account), which effectively converts the broker into a manager of the investment portfolio given their ability to trade stocks without the prior approval of the investor. With the advent of discount brokers in the 1970s, most investors now trade online in self-directed accounts, with little or no commission costs.
A wrap account is a combined investment account where all of the fees associated with the account are wrapped into a single management fee. The fee is usually based on assets under management (AUM) and ranges from 1% to 3% annually. This total fee includes all of the normal costs of the account, including trading commissions, management and administrative costs. The key advantage of a wrap account over a discretionary brokerage account is the elimination of potential “churning” or overtrading in an account that charges trading commissions.
A managed account is one owned by a single investor, whether individual or institutional, and managed by a professional money manager hired to handle the account. These accounts are most often used by high-net-worth individuals or institutions as the minimums for these accounts are often $250,000 or more.
A custodial account is an account that is managed for the benefit of a minor beneficial owner of the account. Often, these are accounts that are established under the Uniform Gifts to Minors Act (UGMA) where a parent or guardian makes an irrevocable gift to the minor which is then managed by the giver, or custodian. These types of accounts may be established for specific purposes, such as saving for college, or simply for the minor’s benefit. Once the beneficiary reaches the age of majority (18 or 21, depending on the jurisdiction), the assets in the account become the sole possession of the beneficiary.
Often in finance and investing, we talk of basis points, but what are they? A basis point is simply one one-hundredth of one percent, or 0.01%. So, when you read about the Federal Reserve raising interest rates by 25 basis points, they raised by 0.25% or a quarter of a percentage point. Where we often see basis points in individual investing is the management fees for certain mutual funds, particularly large index funds which can often be just a few basis points.