Key Takeaways
- Broker trades without prior client approval.
- Broker acts as fiduciary for client's interests.
- Requires written authorization or power of attorney.
- Offers convenience but demands high client trust.
What is Discretionary Account?
A discretionary account is an investment account that allows a broker or financial advisor to make trading decisions on your behalf without needing prior approval for each transaction. This authority is granted through a written agreement or power of attorney, giving the advisor control over buying and selling securities according to your investment goals.
Discretionary accounts differ from non-discretionary accounts where you must approve every trade, making them suitable if you prefer a hands-off approach to managing your portfolio.
Key Characteristics
Discretionary accounts possess distinct features that enhance convenience and oversight:
- Fiduciary Duty: Brokers managing a discretionary account must act in your best interest, aligning their decisions with your financial objectives.
- AAA Rule: Trades involve discretion over Asset, Action, and Amount, as explained in the AAA definition.
- Regulatory Oversight: Enhanced supervision ensures all discretionary trades are reviewed promptly to protect your interests.
- Wrap Accounts: These accounts often use a wrap fee structure that bundles management and trading costs into one transparent fee.
- Convenience: Ideal for hands-off investors who want professional management without daily involvement.
How It Works
With a discretionary account, your broker exercises authority over three key elements of each trade: which security to buy or sell, the action to take, and the quantity involved. This flexibility allows timely execution aligned with market conditions and your goals.
The advisor uses your investment profile and risk tolerance to make decisions without consulting you for each transaction, streamlining the process. This approach is especially useful if you lack the time or expertise to manage your portfolio actively.
Examples and Use Cases
Discretionary accounts are widely used across various investment contexts, including individual and institutional portfolios:
- Individual Investors: Many use discretionary accounts to delegate daily trading, benefiting from professional oversight.
- Institutional Clients: Pension funds and trusts often grant discretionary authority to asset managers to optimize returns.
- Corporate Investments: Companies like Delta may engage discretionary managers to oversee certain investment accounts as part of treasury operations.
- Cost Efficiency: Investors choosing low-cost index funds within discretionary accounts reduce fees while obtaining professional management.
Important Considerations
Before opening a discretionary account, ensure you fully trust your financial professional since they will act without explicit approval for each trade. Understand the fee structure, especially if it’s a wrap account, to avoid unexpected costs.
Also, review your account statements regularly to monitor activity. For those new to investing, exploring options with best online brokers can help you find professionals who offer discretionary services aligned with your goals.
Final Words
Discretionary accounts give your broker authority to make swift investment decisions aligned with your goals, which can enhance responsiveness and efficiency. To ensure this arrangement fits your needs, compare fee structures and discuss the scope of authority with your advisor before committing.
Frequently Asked Questions
A discretionary account is an investment account where a broker or financial advisor has the authority to make trading decisions on your behalf without needing your approval for each transaction, based on a written agreement or power of attorney.
In a discretionary account, the broker decides which securities to buy or sell, the action to take, and the amount to trade. This is often referred to as the "AAA" rule, covering Asset, Action, and Amount.
Discretionary accounts offer convenience for clients who may lack the time or expertise to manage their investments, provide professional management aligned with your financial goals, and usually come with a streamlined fee structure through wrap accounts.
Since brokers have broad authority, there is a risk of unsuitable or excessive trading if they don’t act in your best interest. You also have less direct control over individual investment decisions, which requires a high level of trust in your financial professional.
Unlike discretionary accounts, non-discretionary accounts require the broker to get your approval before making any trades. Brokers can recommend investments but cannot execute trades without your explicit consent.
Discretionary accounts are subject to enhanced regulatory oversight, including prompt supervisory reviews of all discretionary trades, ensuring brokers act as fiduciaries and prioritize your best interests.
A wrap account is a type of discretionary account that bundles asset management and account maintenance services into a single fee, rather than charging separate commissions for each trade, making costs more predictable.
While discretionary accounts grant brokers authority to trade without prior approval, unauthorized trading can still be a concern, especially if a broker acts outside the agreed terms or does not act in your best interest.
