A discretionary account is an investment account that grants an authorized broker the authority to make investment decisions on behalf of the client without requiring prior consent for each transaction. This includes buying and selling securities such as stocks, bonds, and other financial instruments.
Key Features
A discretionary account typically includes the following features:
- Authorized Control: The broker has the autonomy to execute trades on the client’s behalf.
- Client Objectives: Investments are made in alignment with the client’s financial goals, risk tolerance, and investment strategy.
- Management Fee: Clients often pay management fees for this service, which can be a flat fee or a percentage of assets under management.
Benefits of Discretionary Accounts
Professional Expertise
One of the primary advantages of a discretionary account is the access to professional expertise. Brokers and investment managers bring a wealth of knowledge and experience to decision-making, potentially optimizing portfolio performance.
Time-Saving
Discretionary accounts save clients significant time by relieving them of the need to monitor the market and make continuous investment decisions. Clients can trust their broker to manage the account with expertise and efficiency.
Quick Reaction to Market Changes
Discretionary accounts enable brokers to react swiftly to market fluctuations. Immediate decisions can be made to capitalize on market opportunities or to mitigate risks, which is crucial in volatile markets.
Drawbacks of Discretionary Accounts
High Management Fees
While professional management can be beneficial, it often comes at a cost. Discretionary accounts typically involve higher management fees compared to non-discretionary accounts. These fees can erode overall profits, especially if the performance of the investments doesn’t justify the costs.
Potential Conflicts of Interest
There is a potential risk of conflicts of interest. Brokers might be incentivized to make trades that earn them higher commissions rather than what’s in the best interest of the client.
Lack of Control
Clients relinquish a significant degree of control over their investments. While this can be advantageous for some, others may find it disconcerting not to have a say in individual transaction decisions.
Examples and Case Studies
Example 1: High-Net-Worth Individual
A high-net-worth individual might opt for a discretionary account to leverage the expertise of a seasoned investment manager. This setup allows for a tailored investment strategy aligned with long-term financial goals without requiring the client’s constant involvement.
Example 2: Institutional Investor
Institutional investors, such as pension funds or endowments, often use discretionary accounts to manage large portfolios. The scale and complexity of their investments necessitate a professional approach to portfolio management.
Related Terms
- Non-Discretionary Account: Contrarily, a non-discretionary account requires client consent for each transaction. The broker can make recommendations, but final approval must come from the account holder.
- Fiduciary Duty: A discretionary account is often governed by fiduciary duties, meaning the broker is legally obligated to act in the client’s best interest.
FAQs
Are discretionary accounts suitable for all investors?
How are discretionary account fees structured?
Summary
Discretionary accounts provide an efficient way for clients to manage their investments through professional brokers, offering advantages such as expert guidance and quick market reaction. However, these benefits come at a cost, often involving higher fees and a loss of direct control over individual transactions. Suitable for high-net-worth individuals and institutional investors, discretionary accounts can be a valuable tool when managed by trusted and experienced professionals.
References
- Financial Industry Regulatory Authority (FINRA): Understanding Discretionary Accounts
- U.S. Securities and Exchange Commission (SEC): Investment Adviser Guidance
