Discretionary vs. Non-Discretionary Management

An important distinction to keep in mind when looking for financial guidance is discretionary and non-discretionary management. Put simply, the former is an arrangement where your advisory professional will actively manage and trade investments on your behalf, while the latter is one where a manager must consult you first before making any decisions.

In this article, we’ll outline both types of investment management and explain the difference between them. We’ll also go over some important factors to consider when choosing between the two and highlight some ways to maintain accountability with a discretionary advisor.

Discretionary Managers

Portfolio managers with discretionary control have the authority to execute trades and make investment decisions without your direct approval. They work on your behalf and are in charge of overseeing the direction and strategy of your assets.

According to Kelly Palmer, CFA, founder and Chief Wealth Officer at The Wealthy Parent, “When you choose to work with a discretionary advisor you generally sign an agreement that gives them the authority to make purchases and sales in your accounts whenever they determine it is prudent.” For instance, if they deem it necessary, they would be able to buy stocks or positions in mutual funds in your name. They would also be able to sell off assets if they believe that doing so would benefit your overall strategy or bottom line.

Below are some of the key characteristics of a discretionary advisor to consider:

• Authority. Discretionary advisors can buy and sell investment positions, implement asset allocation and diversification strategies, and make other financial decisions on behalf of clients without prior approval.
• Responsibility. These advisors must act in their client’s best interest and make decisions that align with their risk tolerance and financial goals.
• Flexibility. Wielding discretionary authority allows them to capitalize on market opportunities as they arise or manage risk whenever necessary.
• Regular updates. Managers generally maintain frequent contact with clients and provide portfolio performance updates to them regularly.
• Fees. Many firms that offer advisor-directed programs use a fee structure that’s based on your assets under management (AUM), giving them an incentive to ensure your portfolio grows under their watch.

Keep in mind that a discretionary relationship is typically an ongoing one. Commonly, you’ll entrust an individual or a company to manage your account and keep your investments on track for the long haul. If you’re thinking of hiring a company or specific person, consider researching their business practices and investment philosophies.

Joseph Catanzaro, CFP^®, financial advisor at Oak & Stone Capital Advisors in Ambler, Pennsylvania, highlights that “[it’s] essential to review the manager’s track record and reputation, ensuring that their investment philosophy aligns with your financial goals and risk tolerance.” One of the best ways to learn more about a firm or individual is by looking up their Form ADV on the SEC’s Investment Adviser Public Disclosure (IAPD) website.

Trust is the most essential factor in your relationship with an investment manager. Because they have the power to make decisions on your behalf while you aren’t there, you must be sure they’re going to act with integrity and carry out your best interest.

Palmer notes that it’s common for discretionary managers to “work with clients to complete an investor policy statement or ‘IPS’ to ensure you are both clear on the goals and restrictions for the account.” This document might include details about you as an investor and outline accountability standards and responsibilities of you and your advisory team.

Non-Discretionary Managers

Non-discretionary professionals also manage your portfolio, including trading on your behalf; however, where they differ from discretionary advisors is their level of individual power. They must contact you and receive direct permission before making trades or major investment changes.

Here are some key characteristics of these types of experts:

• Advisory role. They help develop financial plans and assist with strategies and other information crucial to the achievement of their client’s goals. While they help execute trades and perform management tasks, they also deliver advice.
• Client involvement and control. The customer makes all investment decisions and may or may not accept their advisor’s recommendations. Clients are also responsible for implementing their financial plans.
• Education and explanations. Clients may need additional information regarding their investment options. A client-directed setup might require your advisor to spend extra time explaining why a particular investment would or wouldn’t work. 
• Fees. These advisors charge clients in a variety of ways, including flat fees, hourly rates, and a percentage of AUM.

A key component to remember in a non-discretionary arrangement is that you maintain overall control of your portfolio’s direction. “While [a non-discretionary professional] must review and manage your account according to your client agreement they cannot transact in the account without your approval,” Palmer notes.

Which One Should You Choose?

Choosing between discretionary or non-discretionary management depends on many factors, including your risk tolerance, how much you trust an advisor or firm, and how much control you prefer to retain over your investments. Bryan Cannon, CEO and Chief Portfolio Strategist at Cannon Advisors in Charlotte, North Carolina, says, “The choice should align with the client’s level of involvement, financial goals, and comfort with either delegating investment decisions to a professional or playing an active role in the decision-making process.”

The discretionary model might be more apt if you want to put your investments in the hands of a professional. This will require a high level of trust on your part. Palmer points out that “[by] choosing a discretionary manager you are truly outsourcing the important task of investing your portfolio.” As mentioned, a manager with this kind of power will be able to control all facets of your portfolio, including the securities you hold and how much money you spend.

In what cases would a person want to hand off their portfolio to a qualified manager? Per Cannon, “Discretionary management is often well-suited for clients seeking a hands-off approach, such as busy professionals or individuals with complex financial situations, who prefer professional oversight and a comprehensive solution.”

A non-discretionary arrangement, per Catanzaro, “may be preferable for clients who desire greater control over their investment decisions, have a higher level of financial knowledge, or simply want to be more directly involved in each investment choice.” Under this type of management, you get the final say over all decisions and purchases. Therefore, you bear the responsibility for your decisions and don’t have to worry that your portfolio could shift away from your vision.

Maintaining Accountability with Discretionary Advisors

A common concern that comes with enlisting the help of a discretionary manager is whether they’re fulfilling your best interest. In most cases, your professional should be a fiduciary and have plenty of experience working in the field and with clients like you. This is especially the case if they work at a reputable company or carry titles such as Chartered Financial Analyst (CFA), Chartered Alternative Investment Analyst (CAIA), or Investment Advisor Representative (IAR). Individuals with these are bound by their title-issuing organization or the government to put your wishes above theirs and avoid conflicts of interest.

But when the rubber meets the road and your advisor begins managing your investments, how do you truly know they’re keeping your desires in mind? While it’s generally good to let your expert handle specifics, it’s wise to stay educated and follow up with them regularly.

Cannon says, “To ensure their discretionary manager acts in their best interest, clients should maintain clear communication, request transparency regarding fees and potential conflicts, regularly monitor performance, and stay educated about financial markets.”

To maintain a standard of accountability with your discretionary professional, it’s also vital that you both fully understand the terms of your agreement.

“Staying informed, verifying regulatory compliance, and carefully reviewing all agreements are key steps in fostering a trustful client-manager relationship,” Cannon emphasizes.

Frequently Asked Questions

How can I be sure my discretionary advisor is acting in my best interest?

One of the most effective ways to make sure your discretionary manager has your best interest at heart is to stay informed on the happenings of your portfolio. This means discussing changes with your advisor and remaining clear with each other on your objectives.

It’s also imperative to hire a manager who upholds a fiduciary standard. Below are some typical signs of high-quality financial advisory or managerial professionals:

• Uses a fee-only structure and doesn’t accept commissions.
• Carries titles such as CFA, CFP, CAIA, or IAR.
• Places a link to a legitimate Form ADV filing with the SEC on their website, displaying transparency.
• Clearly outlines an investment philosophy on their website, Form ADV, or both.
• Has a high AUM, signaling that they serve lots of clients.

What is the primary advantage of discretionary management?

The primary benefit of discretionary management is that you don’t have to spend time picking investments, deciding when to buy or sell, or risk losses because of inexperience. Instead, you rely on a, generally, much more experienced person or team of experts to oversee your portfolio.

What is the main advantage of non-discretionary management?

A significant benefit of non-discretionary management is that you maintain control. You still save some time by allowing someone else to execute trades; however, you keep a heightened level of awareness and decision-making ability over what happens to your assets and why.