What Is a Discretionary Account & How Does It Work?

A discretionary account offers a specific arrangement in the financial world where an investor grants a financial professional authority over their investment decisions. This article clarifies the nature of these accounts, detailing their operational mechanics and distinguishing them from other investment management approaches. It will also explore the typical circumstances under which such accounts are utilized and the frameworks in place to ensure proper oversight.

Defining a Discretionary Account

A discretionary account is an investment account where the account holder grants a financial professional, such as an investment advisor, the authority to make investment decisions and execute trades without seeking prior approval for each transaction. This means the professional has the freedom to buy, sell, or hold securities on behalf of the client, provided these actions align with the agreed-upon investment strategy.

This account requires a significant degree of trust between the account holder and the financial professional. The client delegates the day-to-day management of their portfolio, trusting the professional to act in their best interest based on established financial goals. This delegation allows the advisor to react swiftly to market changes or opportunities without needing to contact the client for approval on each trade.

Key Elements of Discretionary Management

Establishing a discretionary account involves a formal authorization process, such as a written agreement or a limited power of attorney, which explicitly grants the financial professional investment authority. This document outlines the scope of the professional’s discretion, which can be broad or limited to certain asset classes, transaction types, or investment strategies.

Before trading begins, the financial professional and account holder must establish the investor’s specific investment objectives, risk tolerance, and financial goals. This initial profiling forms the basis of the investment strategy the advisor will implement. Communication shifts from trade-by-trade notifications to regular performance reviews and periodic statements, allowing the client to monitor progress. The professional manages the portfolio in line with this agreed-upon strategy, adapting to market conditions while adhering to the client’s defined parameters.

Comparison to Non-Discretionary Accounts

Discretionary accounts differ significantly from non-discretionary accounts, primarily concerning the level of client involvement in daily trading decisions. In a non-discretionary account, the financial professional only provides investment recommendations, and every trade requires client approval before execution. The client retains direct control over each transaction.

Conversely, with a discretionary account, the financial professional has authority to execute trades directly. This distinction impacts both the client and the advisor. For clients, it means less day-to-day involvement, while for professionals, it allows for more agile portfolio management and immediate strategy execution. For example, if a market opportunity arises, a discretionary manager can act immediately, whereas a non-discretionary advisor would first need to obtain client consent.

Common Scenarios for Discretionary Accounts

Discretionary accounts appeal to individuals with limited time to actively manage investments. These investors prefer to delegate daily portfolio oversight to a professional, allowing them to focus on other commitments. This arrangement is beneficial for those who lack the specialized expertise or desire to make frequent, informed investment decisions.

Discretionary accounts are chosen by individuals or entities managing complex portfolios that require continuous attention and specialized knowledge. This includes high-net-worth individuals, trusts, or institutional accounts where a designated manager oversees a diverse array of assets. The delegation of authority ensures the portfolio benefits from professional management and timely adjustments without constant client input.

Oversight and Accountability

Discretionary accounts and the financial professionals who manage them operate under specific regulatory frameworks designed to protect investors. Investment advisors in the United States are overseen by regulatory bodies such as the Securities and Exchange Commission (SEC) or state securities regulators, depending on their assets under management. These bodies establish rules and guidelines to ensure fair practices and investor protection.

A principle governing these accounts is the financial professional’s fiduciary duty, which obligates them to act in the client’s best interest. This duty extends to all aspects of the client relationship, including investment advice and execution. Accountability is reinforced through requirements for regular reporting and transparency, ensuring account holders receive periodic statements and performance reviews to monitor their investments and the professional’s adherence to the agreed-upon strategy.