Discretionary Account

What is a Discretionary Account?

A discretionary account is an investment account where the owner, typically an investor, grants a financial advisor, broker, or money manager the legal authority to make investment decisions and execute trades on their behalf without requiring prior approval for each transaction. This contrasts with a non-discretionary account, where the advisor must obtain the client's explicit permission before executing any trade. The core principle of a discretionary account is the delegation of investment authority, allowing the professional to act swiftly on market opportunities or react to changes without delay.

For real estate investors, who often dedicate significant time and capital to property acquisition and management, a discretionary account can be an invaluable tool for managing other aspects of their wealth, such as liquid reserves, retirement portfolios, or diversified investments outside of direct real estate. It allows them to maintain focus on their core real estate business while ensuring their broader financial portfolio is professionally managed according to their established goals and risk tolerance.

How Discretionary Accounts Work

The operation of a discretionary account is built upon a foundation of trust, clear communication, and a formal agreement. It begins with the investor selecting a qualified financial professional and establishing a comprehensive understanding of their financial objectives.

Key Operational Elements

• Written Authorization: The investor must sign a formal document, often called a Limited Power of Attorney (LPOA) or a discretionary trading agreement, which explicitly grants the advisor the authority to make investment decisions. This document outlines the scope of the advisor's power and any limitations.
• Investment Policy Statement (IPS): Before any trades occur, the investor and advisor collaborate to create an IPS. This critical document details the investor's financial goals, risk tolerance, time horizon, liquidity needs, and any specific investment preferences or restrictions. The IPS serves as a guiding framework for all investment decisions made by the advisor.
• Fiduciary Duty: Advisors managing discretionary accounts typically operate under a fiduciary standard, meaning they are legally obligated to act in the client's best interest at all times. This is a higher standard than the suitability standard, which only requires recommendations to be suitable for the client.
• Reporting and Review: Investors receive regular statements detailing all transactions, portfolio performance, and holdings. Periodic review meetings with the advisor are essential to assess progress against the IPS, discuss market conditions, and make any necessary adjustments to the investment strategy.

Advantages and Disadvantages for Investors

Discretionary accounts offer distinct benefits, particularly for busy real estate investors, but also come with inherent drawbacks that must be carefully weighed.

Advantages

• Time Savings: Investors are freed from the day-to-day burden of monitoring markets, researching investments, and executing trades, allowing them to focus on their primary real estate ventures or other commitments.
• Professional Expertise: Access to the knowledge, experience, and resources of a professional money manager who can make informed decisions based on market analysis and investment strategies.
• Timely Execution: Advisors can act quickly on market opportunities or respond to adverse conditions without needing to contact the client for approval, potentially leading to better outcomes.
• Emotional Detachment: Professional management can help mitigate emotional decision-making, which often leads to poor investment choices during volatile market periods.
• Diversification and Asset Allocation: Advisors can implement sophisticated diversification strategies and maintain optimal asset allocation tailored to the investor's risk profile.

Disadvantages

• Loss of Control: Investors relinquish direct control over individual investment decisions, which can be a concern for those who prefer to be hands-on with their portfolios.
• Fees: Discretionary accounts typically incur higher management fees (often a percentage of assets under management, e.g., 0.5% to 2% annually) compared to self-directed accounts or non-discretionary advisory services.
• Potential for Misaligned Interests: While fiduciaries are legally bound to act in the client's best interest, conflicts of interest can still arise, especially if the advisor earns commissions on certain products or trades.
• Advisor Risk: The performance of the account is heavily dependent on the advisor's skill, judgment, and integrity. Poor advisor performance can lead to underperforming returns or even losses.

Key Considerations Before Opening a Discretionary Account

Before entrusting your assets to a third party, careful consideration and due diligence are paramount.

1. Advisor Selection: Research and vet potential advisors thoroughly. Look for credentials (e.g., CFP, CFA), experience, track record, fee structure, and a clear understanding of their investment philosophy. Ensure they are a registered investment advisor (RIA) and operate under a fiduciary standard.
2. Understand the Fee Structure: Clarify all fees, including advisory fees (asset-based), trading commissions, and any other administrative costs. A typical fee might be 1% of assets under management (AUM) for portfolios up to $1 million, potentially decreasing for larger portfolios.
3. Define Your Investment Policy Statement (IPS): This is your blueprint. Be explicit about your risk tolerance (e.g., conservative, moderate, aggressive), investment goals (e.g., capital preservation, growth, income), and any specific restrictions (e.g., no investments in certain industries). A well-defined IPS protects both you and the advisor.
4. Review Reporting and Communication: Understand how often you will receive reports and how frequently you will meet with your advisor. Regular communication is vital to ensure the strategy remains aligned with your evolving financial situation.
5. Exit Strategy: Know the process for terminating the agreement, transferring assets, and any associated costs or notice periods.

Real-World Examples for Real Estate Investors

Real estate investors can leverage discretionary accounts in several practical ways to optimize their overall financial strategy.

Example 1: Managing Liquid Reserves

Sarah, a successful fix-and-flip investor, maintains a significant cash reserve of $500,000 for unexpected property repairs, market downturns, or quick acquisition opportunities. Instead of letting this capital sit in a low-yield savings account, she opens a discretionary account with a financial advisor. Her IPS specifies a conservative strategy focused on capital preservation and moderate income, investing in short-term government bonds, high-yield savings, and dividend-paying ETFs. The advisor charges a 0.75% annual fee. In a year, the account generates a 3.5% return, or $17,500. After the $3,750 fee ($500,000 * 0.0075), Sarah nets $13,750, significantly more than she would have earned in a traditional savings account, all while her advisor manages the liquidity and risk, allowing Sarah to focus on her property projects.

Example 2: Diversifying Beyond Direct Real Estate

David, a multi-family property owner, has accumulated substantial equity in his properties but wants to diversify his wealth beyond physical real estate. He allocates $1,000,000 to a discretionary account with an aggressive growth strategy, aiming for long-term capital appreciation through a diversified portfolio of technology stocks, emerging market funds, and real estate investment trusts (REITs). His advisor, with a 1.0% annual fee, actively manages the portfolio, rebalancing as needed and capitalizing on market movements. Over a year, the portfolio grows by 12%, or $120,000. After the $10,000 fee, David's net gain is $110,000, providing him with diversified exposure and growth potential without diverting his attention from his core property management responsibilities.

Example 3: Retirement Portfolio Management

Maria, a seasoned commercial real estate investor, has a self-directed IRA with $750,000 that she wants professionally managed for retirement. She establishes a discretionary account within her IRA, setting a moderate risk profile with a focus on income and long-term growth. Her advisor, charging 0.8% annually, constructs a portfolio of blue-chip stocks, corporate bonds, and preferred shares. The advisor's active management helps navigate interest rate changes and market volatility. In a year, the portfolio yields an 8% return, or $60,000. After the $6,000 fee ($750,000 * 0.008), Maria's net return is $54,000, ensuring her retirement savings are on track while she continues to manage her commercial properties.