Discretionary Account¶
OVERVIEW¶
A discretionary account is a brokerage account where the account holder grants written authorization to a broker or investment manager to buy and sell securities on their behalf without requiring prior approval for each individual transaction. The manager holds legal authority to select assets, timing, and order size based on the client's stated objectives.
Note
Discretionary accounts are heavily regulated by the SEC and FINRA to prevent unauthorized trading and churning. This differs fundamentally from a non-discretionary account, where the broker must secure client consent for every trade.
| Account Type | Client Approval Required | Manager Authority | Typical Use Case |
|---|---|---|---|
| Discretionary | No | Full execution authority | Wealth management, hedge funds |
| Non-Discretionary | Yes, per trade | Execution only | Active self-directed traders |
HOW IT IS CALCULATED AND MANAGED¶
Discretionary authority is established through a formal Limited Power of Attorney (LPOA) document. Account performance is measured against a benchmark and evaluated using risk-adjusted return metrics.
Annual Management Fee Formula:
Example calculation:
| Variable | Value |
|---|---|
| Portfolio AUM | $500,000 |
| Agreed Fee Percentage | 1.5% |
| Annual Fee | $7,500 |
| Billing Frequency | Quarterly |
Note
Brokers must pass a suitability test for every trade, confirming each position aligns with the client's risk tolerance, time horizon, and financial situation. Margin usage is strictly capped by the broker-dealer's risk management protocols.
FEATURES¶
Worked Example¶
A high-net-worth individual opens a discretionary account with a wealth management firm. The client signs an LPOA authorizing the firm to manage a $2,000,000 portfolio with a mandate for long-term capital appreciation and a restriction against shorting equities.
- Portfolio manager identifies a technical breakout in MSFT
- Purchases $200,000 worth of shares at $400 per share
- No client call or approval is required prior to execution
- Trade executes immediately under existing LPOA authority
- Client receives trade confirmations after the fact
The manager retains ongoing authority to rebalance the portfolio, exit the position if the thesis invalidates, or adjust stop losses at any time.
Who Uses Discretionary Accounts¶
| User Type | Purpose |
|---|---|
| High-net-worth individuals | Passive, professionally managed allocations |
| Hedge funds | Full portfolio management with internal mandates |
| Wealth management firms | Long-term capital growth strategies |
| Managed futures accounts | Systematic and discretionary futures execution |
| Institutional prop desks | Discretionary authority over firm capital |
Tip
Retail traders do not use discretionary accounts for active trading. They use them for passive or professionally managed portfolio allocations where direct involvement is not required.
LIMITATIONS AND COMMON MISCONCEPTIONS¶
Note
A discretionary account does not grant the broker unlimited power. The LPOA restricts the manager strictly to the strategies and asset classes outlined in the signed agreement.
| Misconception | Reality |
|---|---|
| Discretionary accounts guarantee outperformance | Managers remain fully subject to market risk and behavioral biases |
| The broker has unlimited trading authority | Authority is bounded by the specific LPOA terms |
| Fee structures align manager and client interests | AUM-based fees incentivize asset growth, not percentage return maximization |
Conservative, benchmark-hugging behavior is a known risk where fee structures incentivize managers to grow AUM rather than maximize returns.