A discretionary account, in the context of finance and investments, is a type of investment account in which the account holder gives a broker or financial advisor the authority to make buy and sell decisions on their behalf. This type of account is also known as a managed account or a wrap account. The financial advisor or broker has the discretion to make investment decisions without requiring the approval of the account holder for each transaction.
The concept of a discretionary account is rooted in the idea of trust and expertise. The account holder trusts that the financial advisor or broker has the necessary knowledge, experience, and skills to make sound investment decisions that will help them achieve their financial goals. This arrangement can be beneficial for individuals who lack the time, interest, or expertise to manage their own investments.
Types of Discretionary Accounts
Discretionary accounts can be categorized into two main types: individually managed accounts and pooled funds. Individually managed accounts are personalized investment portfolios that are tailored to the specific needs and goals of the account holder. The financial advisor or broker makes investment decisions based on the account holder’s risk tolerance, investment objectives, and other personal circumstances.
Pooled funds, on the other hand, are investment funds that pool the resources of multiple investors. The financial advisor or broker makes investment decisions on behalf of all the investors in the fund. This type of discretionary account is typically used by investors with smaller amounts of capital, as it allows them to access a diversified portfolio that they might not be able to afford on their own.
Individually Managed Accounts
Individually managed accounts are often used by high-net-worth individuals who require a more personalized approach to investment management. The financial advisor or broker will work closely with the account holder to understand their financial goals, risk tolerance, and investment preferences. Based on this information, they will create a customized investment strategy and portfolio for the account holder.
One of the main advantages of individually managed accounts is the level of customization and control that they offer. The account holder can specify certain investment preferences, such as excluding certain sectors or companies from their portfolio, or focusing on investments that align with their ethical or social values. Additionally, individually managed accounts typically offer a higher level of transparency compared to pooled funds, as the account holder can see exactly where their money is invested and how it is performing.
Pooled Funds
Pooled funds, also known as mutual funds or investment funds, are a type of investment vehicle that pools the money of multiple investors to invest in a diversified portfolio of securities. The financial advisor or broker makes investment decisions on behalf of all the investors in the fund, based on the fund’s investment objectives and strategy.
One of the main advantages of pooled funds is that they allow investors with smaller amounts of capital to access a diversified portfolio. By pooling their resources with other investors, they can afford to invest in a wider range of securities, which can help to spread risk and potentially enhance returns. Additionally, pooled funds are managed by professional fund managers, who have the expertise and resources to research and select investments.
Advantages and Disadvantages of Discretionary Accounts
Discretionary accounts offer several advantages, including professional management, convenience, and potential access to a wider range of investments. However, they also come with some potential disadvantages, such as fees, lack of control, and the risk of poor performance.
One of the main advantages of discretionary accounts is that they are managed by professionals. This can be particularly beneficial for individuals who lack the time, interest, or expertise to manage their own investments. A professional financial advisor or broker can use their knowledge and experience to make informed investment decisions, potentially leading to better investment outcomes.
Advantages
Another advantage of discretionary accounts is convenience. With a discretionary account, the account holder does not need to worry about making buy and sell decisions, monitoring their investments, or staying up-to-date with market news and trends. Instead, they can delegate these tasks to their financial advisor or broker, freeing up their time for other activities.
Discretionary accounts can also provide access to a wider range of investments. Financial advisors and brokers often have access to investment opportunities that are not available to individual investors. Additionally, by pooling their resources with other investors in a pooled fund, individuals with smaller amounts of capital can afford to invest in a diversified portfolio.
Disadvantages
One of the main disadvantages of discretionary accounts is the fees. Financial advisors and brokers typically charge a fee for their services, which can eat into the account holder’s returns. These fees can vary widely, so it’s important for account holders to understand exactly what they are paying for and to compare fees before choosing a financial advisor or broker.
Another potential disadvantage of discretionary accounts is the lack of control. While some account holders may appreciate the convenience of delegating investment decisions to a professional, others may prefer to have more control over their investments. With a discretionary account, the account holder gives up the ability to approve each transaction, which may not be suitable for everyone.
Regulation of Discretionary Accounts
Discretionary accounts are subject to regulation by financial regulatory bodies. In the United States, for example, discretionary accounts are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). These regulatory bodies set rules and standards to protect investors and ensure the integrity of the financial markets.
Financial advisors and brokers who manage discretionary accounts are required to act in the best interests of their clients. This means that they must make investment decisions that they believe are suitable for the client, based on the client’s financial situation, risk tolerance, and investment objectives. They are also required to disclose any conflicts of interest and to treat all clients fairly.
Securities and Exchange Commission (SEC)
The SEC is a federal agency that regulates the securities industry in the United States. It is responsible for enforcing federal securities laws, regulating securities exchanges and other securities organizations, and protecting investors. The SEC sets rules and standards for discretionary accounts, including requirements for disclosure, recordkeeping, and suitability of investment decisions.
Financial advisors and brokers who manage discretionary accounts are required to register with the SEC and to comply with its rules and regulations. They are subject to regular inspections and audits by the SEC to ensure compliance.
Financial Industry Regulatory Authority (FINRA)
FINRA is a self-regulatory organization that regulates brokerage firms and their registered representatives in the United States. It is responsible for enforcing rules for fair and ethical business practices, protecting investors, and ensuring the integrity of the securities markets.
Financial advisors and brokers who manage discretionary accounts are required to register with FINRA and to comply with its rules and regulations. They are subject to regular inspections and audits by FINRA to ensure compliance.
Choosing a Financial Advisor or Broker for a Discretionary Account
Choosing a financial advisor or broker for a discretionary account is an important decision. The account holder is entrusting their financial future to this person, so it’s crucial to choose someone who is trustworthy, competent, and aligned with their financial goals and values.
There are several factors to consider when choosing a financial advisor or broker for a discretionary account. These include the advisor’s or broker’s qualifications, experience, investment philosophy, fees, and regulatory record. It’s also important to consider the advisor’s or broker’s communication style and whether they are a good fit on a personal level.
Qualifications and Experience
The financial advisor or broker’s qualifications and experience are important factors to consider. It’s important to choose someone who has the necessary knowledge and skills to manage your investments effectively. Look for advisors or brokers who have relevant qualifications, such as a Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA) designation, and who have a track record of successful investment management.
Experience is also important. An advisor or broker who has been in the industry for many years and has managed investments through different market conditions is likely to have a better understanding of the markets and a more refined investment strategy than someone who is new to the industry.
Investment Philosophy
The financial advisor or broker’s investment philosophy is another important factor to consider. This refers to their approach to investing, including their beliefs about how to achieve investment success, their preferred types of investments, and their approach to risk management. It’s important to choose an advisor or broker whose investment philosophy aligns with your own beliefs and risk tolerance.
For example, if you are a conservative investor who prefers to take a slow and steady approach to investing, you might not be comfortable with an advisor or broker who believes in taking high risks in pursuit of high returns. On the other hand, if you are an aggressive investor who is comfortable with risk, you might not be satisfied with an advisor or broker who takes a conservative approach to investing.
Conclusion
In conclusion, a discretionary account is a type of investment account in which the account holder gives a financial advisor or broker the authority to make investment decisions on their behalf. This type of account can be beneficial for individuals who lack the time, interest, or expertise to manage their own investments. However, it also comes with potential disadvantages, such as fees and lack of control, and it’s important to choose a financial advisor or broker carefully.
Discretionary accounts are subject to regulation by financial regulatory bodies, and financial advisors and brokers who manage these accounts are required to act in the best interests of their clients. If you are considering opening a discretionary account, it’s important to understand how these accounts work, the advantages and disadvantages, and the factors to consider when choosing a financial advisor or broker.
