The difference between discretionary and non-discretionary accounts is critical, but very few individual investors even know this difference exists. The biggest difference is that with a discretionary account, your broker can make any decisions they want with your investment funds. That is not the case with a non-discretionary account where you must permit each decision. You can find a financial advisor who can guide you through this process, ensuring that even if you have a discretionary account, your best interests are managed at all times.
What Is a Discretionary Investment Account?
With a discretionary investment account, sometimes known as a managed account, your broker has the authority to make individual trades in your portfolio without seeking your approval. They have the discretion to buy or sell assets on their own.
A discretionary investment account is not a blank check. In most cases, your advisor will still have either an ethical or fiduciary duty to make decisions in your best interest, and they will also be bound by whatever investment strategy you agreed on. They also cannot access money that you haven’t placed in this specific portfolio. For example, they cannot use a linked bank account to make purchases at their discretion.
However, within those boundaries, your broker will have the authority to execute trades without seeking client approval first. They can use their own judgment as to what’s best for the portfolio.
What Is a Non-Discretionary Account?
In a non-discretionary account, a broker has no independent authority to execute trades. They can only buy and sell assets at their client’s instructions and have a duty to do so at the best price possible based on when their client gives those instructions. The broker does not have any discretion over which investments to make and they have no discretion over when to make any given trade.
Brokers in a non-discretionary account can typically still advise their clients. Often in these accounts, the client and the broker will develop an investment strategy together and the broker will find specific investments that they think meet this strategy. They will then seek the client’s explicit approval to execute trades that the broker thinks are wise.
Benefits of Discretionary vs. Non-Discretionary Accounts
Each style of account has its benefits and drawbacks, which are all important to analyze now that we understand what each account is and how they work. The largest benefits are going to be related to the way that investments are made and how much you’ll be charged for using a specific type of broker or investment account. The largest benefits, depending on what account you use, are:
1. Passive vs. Active Investing
Discretionary accounts are often good for passive investors who want to balance active investment with a hands-off approach to their portfolio. By letting your broker make decisions independently, you can have more active management of your account without needing to make those trades yourself.
Non-discretionary accounts are good for investors who either want to take a much more hands-on approach to their money or who would like to keep an extremely passive approach to investment. With this account, you can make all of your own trading decisions while still benefiting from a broker’s advice, or you can lock in a long-term position and prevent your broker from altering it.
Although it’s important to note that even with a discretionary account your broker is still bound by any instructions you give them. If you want them to leave a certain investment alone, you can simply tell them to do so.
2. Timing And Details
Discretionary accounts can benefit from better timing. If your broker sees a particularly good opportunity, they have the flexibility to pursue it without needing to wait for you to get back to them. This also allows your broker to make small changes regularly according to your instructions. For example, if you want a specific balance of assets or a specific risk profile, your broker can make small changes periodically rather than needing to ask you about a large group of changes all at once.
3. Fees
Non-discretionary accounts typically have lower management fees, sometimes they are significantly less. They also generally have lower minimum investments. This makes it cheaper to open and maintain a non-discretionary account, which is a huge benefit if you’re not investing a large amount or if you’re just dipping your toe into the waters of certain investments.
4. Trust
A non-discretionary account means that no one else has authority over your money. This is extremely important for many investors. Your broker can still find good trades on your behalf and can still make recommendations, but you have the final approval before they buy or sell any assets.
By contrast, a discretionary account requires an enormous amount of trust. You are letting this person make independent decisions with your money, even if they are bound by your instructions. You need to be very comfortable with their judgment to do this, or at least trust their years of experience.
Understanding Risk in Discretionary vs. Non-Discretionary Accounts
Discretionary accounts inherently carry a unique set of risks. Since the financial advisor has the autonomy to make investment decisions, the client is placing a significant amount of trust in the advisor’s expertise and judgment. This can be beneficial if the advisor is experienced and knowledgeable, but it also means that the client is exposed to the risk of poor decision-making. Additionally, the lack of client oversight can lead to a misalignment of investment strategies with the client’s financial goals if not properly communicated.
Non-discretionary accounts offer a different risk profile. The requirement for client approval on each transaction means that investors have more control over their portfolios. This can be reassuring for those who prefer to be actively involved in their investment decisions. However, the need for constant communication and approval can lead to missed opportunities, especially in volatile markets where timing is crucial. The risk here lies in the potential for slower response times to market changes, which can impact the overall performance of the investment portfolio.
Bottom Line
Understanding the differences between discretionary and non-discretionary investment accounts is crucial for investors seeking to align their financial strategies with their personal goals and risk tolerance. Ultimately, the choice between these two types of accounts depends on the investor’s level of expertise, desired involvement and trust in their financial advisor. By carefully considering these factors, investors can make informed decisions that best suit their financial objectives and comfort levels.
Tips for Investment Management
- Finding a financial advisor to manage your investments can be difficult if you don’t know where to start. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- What’s the value of a broker? Investment brokers do much more than just execute trades on your behalf. They also advise you on how to make the most of those investments and your money overall.
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