Discretionary Investing Defined

When you work with a financial planner who seamlessly manages your investments while you enjoy a carefree retirement, that's a match in discretionary investing heaven.
Discretionary Investing Defined

Recently, one of our clients asked us to define Discretionary Investing.

It’s natural to have questions throughout your financial planning journey.  Whether you thoroughly researched your options or you jumped in blindly and now you’re backtracking . . . we’ve got answers for you.  It’s our pleasure to meet you where you are and help you reach those aha! moments of comprehension.

Discretionary Investing!?

What a mouthful, right? Even though it does sound technical, discretionary investing is easy to define!

How Hollywood Portrays Investing

If you’ve ever watched The Wolf of Wall Street, you have a good idea of what a stockbroker is. The stockbroker is the guy who sells investments.  Imagine Leonardo DiCaprio calling you up with an amazing stock investing opportunity!

Some time ago, most people invested just this way. The stockbroker would come to you with a hot stock to buy. Other times, you would reach out to acquire your favored investment.

Although stockbrokers still exist, retirement investing has changed a bit.

Non-Discretionary Investment Management

When you use a stockbroker, they’ll never buy or sell a stock, without first getting your approval. When every trade is personally approved by you, the investor, it is non-discretionary.

Going back to The Wolf of Wall Street, imagine Leonardo DiCaprio phoning you with an investment opportunity. That’s non-discretionary investment management. It’s an antiquated way to manage money.

1980’s era stockbroker antics aside, here’s what non-discretionary investment management looks like today:

  • The advisor calls each client individually before every trade.
  • Next, the advisor makes their investment recommendation to the client.
  • Then, the client gives their approval.
  • A time-stamped note is entered into the advisor’s record-keeping system.
  • Finally, the trade order is placed.

On a surface level, this seems like a pretty good idea. However, it’s actually very cumbersome for both the investor and the advisor. Non-discretionary investing is time-consuming and inefficient.

Discretionary Investment Management

The opposite is the case with discretionary investment management. This is when an investment manager is given authority over a client’s portfolio.

Discretionary investment management means the advisor executes trades on behalf of a client, without the client’s verbal approval for each and every transaction. However – and it’s a big, however – the changes suggested by the advisor must:

  1. Be in the best interest of the client and
  2. Align with the client’s Investment Policy Statement (IPS).

Investment Policy Statement Guiding Discretionary Investment Management

Ideally, before an investment advisor begins managing a client’s money, the two have a chat. During this conversation, the advisor works to determine the client’s goals. Also discussed is the client’s tolerance for risk, and the client’s need to take risk.

The result of this conversation is the creation of the client’s Investment Policy Statement, which outlines how the investment advisor will manage the client’s money.

Which Investment Firms Manage Client Portfolios on a Discretionary and Non-Discretionary Basis?

As you might imagine, most fee-only RIA firms (like ours) manage investments for clients on a discretionary basis. This means we can initiate trades without the client needing to greenlight every transaction.

Big banks and brokerage houses typically manage investments on a non-discretionary basis. Why? Because they sell expensive products that aren’t typically in the best interest of the client.

Selling bad stuff creates a big risk for these firms. Calling the client, getting approval, and time-stamping a note in their administrative system helps to protect them.

Discretionary Investing with CERTIFIED FINANCIAL PLANNER Professionals TM

We’re biased – but we think clients should opt for discretionary investment management by fee-only CFP® professionals using low-cost investments. Why? Because a knowledgable investment advisor championing low-cost investments is likely more qualified to invest your life’s savings.

It’s the same reason you would use a CPA to do your taxes; the CPA can do a better job of preparing a tax return than you can. And, your CPA isn’t going to get your approval for every number they enter into your return. That’s the discretionary part.

In short, discretionary investment management by a qualified investment professional just makes sense.

You have way more interesting things to do with your life than approve every decision your advisor makes; you’ve got to enjoy retirement!