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When investors first set up an account with a brokerage firm, that account is designated as either discretionary or non-discretionary. Unfortunately, many investors are simply unaware of the status of their account or what it means. This is usually because investment brokers fail to properly explain each type of account.

However, knowing what kind of investment account you have is important. The claims available to a victim of investment fraud or broker misconduct depend on the status of your account.

What’s the Difference Between Discretionary and Non-Discretionary Investment Accounts?

The primary difference between discretionary and non-discretionary accounts is the level of authority your broker has over each. For discretionary accounts, also called managed accounts, your broker has the freedom to make trades without contacting you first. However, this does not mean that the broker has freedom to do whatever they want; investors may still place limits or give instructions regarding the kinds of trades the broker is allowed to make.

For non-discretionary accounts, on the other hand, your broker must contact you before conducting any trade. Non-discretionary accounts are better for investors who want to take a more active role in their investments. Non-discretionary brokers still make investment recommendations, but they cannot act on those recommendations before obtaining consent to do so from the investor.

Keep in mind that regardless of the type of account you have, your broker is duty bound to make trades in your best interest. Brokers and financial advisers are required to make trades that are suitable for your goals and risk tolerances. A broker’s failure to do so exposes them to potential liability for unauthorized trading or breach of fiduciary duty. Knowing the status of your account helps an investment fraud lawyer determine what claims you may have.

Which Type of Account Should I Choose?

Because each investor has different needs, neither account will always be better or worse than the other. Instead, each type of account has certain advantages and disadvantages. Whether one type works better for you than the other depends on how you prioritize these differences.

And always remember: your broker is supposed to work for you. If you decide you want to give your broker more or less control, you can always adjust your investing requirements to do so.

Benefits of a Discretionary Account

Because trades in discretionary accounts do not require investor consent, brokers have much more flexibility managing those investments. As a result, the largest benefit of discretionary accounts is your broker’s ability to quickly respond to investment opportunities. 

Consider the following example. You have an account with a broker who manages dozens of accounts besides yours. One day, your broker finds an investment opportunity that is perfect for all the accounts they manage. If your account is discretionary, the broker makes the trade immediately without contacting you, ensuring that it is at the best possible price. If your account is non-discretionary, however, your broker must get your permission before making the trade. This may not make much of a difference if you are the first investor the broker contacts. But because the broker manages dozens of other accounts, you run the risk of losing out on the best price for the investment.

This flexibility also translates to some of the day-to-day management of your account. For example, if you’ve instructed your broker that you want to maintain a balance of 35% stocks to 65% bonds in your portfolio, a discretionary broker can make adjustments to maintain this balance without your consent.

In short, discretionary accounts offer the benefit of being a more passive investment option for the investor. Because you can still place limits on what your broker can do (for example, only investing in certain kinds of stocks), the investor does maintain a certain level of control. But overall, the broker has more freedom to handle the account. Accordingly, a busy investor or one who has a long history with their advisor may find discretionary accounts to be the best option.

Disadvantages of a Discretionary Account

Of course, discretionary accounts do come with some disadvantages. First and foremost, brokerage firms almost always require a higher minimum investment to open a discretionary account. In many cases, this investment must be low- to mid-six figures.

Second, discretionary accounts are usually more expensive because they require a manager to handle risk and trading. Fees for discretionary accounts can be anywhere from 1% to 2% per year depending on the brokerage firm.

Benefits of a Non-Discretionary Account

While discretionary accounts excel at flexibility, non-discretionary accounts provide more control to their investors. Handing over a significant portion of your financial assets to a brokerage firm is a big decision. Some investors may be uncomfortable doing so and may not fully trust their investor to make all the right decisions. In those situations, non-discretionary accounts provide a compromise.

Non-discretionary accounts will be a more attractive choice to investors that want more direct control over their investments. Because their broker must get permission before making a trade, investors will have the final say in all investment decisions. As a result, the investors have the opportunity to assess their broker’s advice before moving forward.

The passive approach of a discretionary account is not for everyone. Thus, investors who want a more hands-on role in their investments may find non-discretionary accounts to be a better option.

Finally, the minimum investment required to open a non-discretionary account is often much lower. People new to investing or investors with smaller portfolios may find non-discretionary accounts more accessible.

Disadvantages of a Non-Discretionary Account

The biggest disadvantage of a non-discretionary account is your broker’s inability to react quickly when an investment opportunity arises. As in the example above, a broker managing dozens of non-discretionary accounts must get consent from investors before executing trades in their respective accounts. If your name is in the middle of that list, the price you pay will depend on how many clients your broker contacted before getting to you. Even if your name is first on the list, non-discretionary accounts may fall victim to the phone tag problem; you may not see or respond to the broker’s request for your permission until after the opportunity has passed.

Hire an Investment Fraud Attorney

At The Law Offices of Robert Wayne Pearce, P.A., we have over 40 years of experience helping investors recover their money from bad investments. If you are the victim of investment fraud or if your broker has failed to invest your money according to your needs, we can help. Contact us today or give us a call at 561-338-0037 for a free consultation.

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