A discretionary account is an investment account that allows an authorized broker or financial advisor to buy and sell securities without requiring the client’s consent for each individual trade.
Explanation and mechanics
To establish a discretionary account, the client signs a formal agreement granting trading authority to a broker. This agreement outlines the parameters the broker must follow, which are based on the client’s investment goals and risk tolerance. The broker is bound by fiduciary duty, meaning they are legally obligated to make trades that align with the client’s financial interests rather than generating commissions for themselves.
The regulations overseeing these accounts depend on the jurisdiction where the broker operates. In the United Kingdom, the Financial Conduct Authority regulates discretionary management. Across the European Union, brokers must comply with the Markets in Financial Instruments Directive II. Regulatory bodies generally require the broker to hold specific qualifications and pass background checks before they are permitted to manage client funds on a discretionary basis.
Financial institutions typically set higher minimum balance requirements for discretionary accounts compared to standard execution-only accounts. The fee structure is usually based on a percentage of the total assets under management. This method charges the client a flat annual or quarterly rate instead of billing for individual transactions.
The client retains full legal ownership of the assets within the discretionary account. The broker has the authority to execute trades, but they are not permitted to withdraw funds or transfer money to external third parties. The client can monitor the broker’s decisions through regular account statements and retains the right to revoke the trading authorization at any time.
Example
An Elephant holding a portfolio of international equities plans to migrate across the continent for several months and will lack reliable internet access. To ensure the portfolio remains actively managed during the journey, the Elephant opens a discretionary account with a licensed broker.
Before departing, the Elephant signs the required agreements and instructs the broker to maintain a moderate risk profile with a focus on agricultural commodities. Two months into the migration, global markets experience a sudden drop in asset prices. The broker identifies an underpriced peanut farming cooperative and decides to buy shares.
Because the account is discretionary, the broker executes the purchase immediately to secure the low price. The broker does not have to wait for the Elephant to find a communication signal and approve the specific trade. The new shares are added to the portfolio, and the transaction is recorded on the monthly statement for the Elephant to review later.