Investing has become easier than ever with the advent of online discount brokers. Often times, you can sign-up for an account, deposit funds, and make your first trade within a day or two. Greater access to tools and information has also leveled the playing field to some extent. Short-term traders have access to real-time news through services like TheFly, while long-term investors can use tools like Intrinio to quickly assess a company’s intrinsic valuation.
But even with these resources, successful trading and investing still requires adequate knowledge, the right temperament, and a time commitment. Investors that don’t know how to read a financial statement won’t have much luck finding undervalued investments and a failure to keep a portfolio updated could end up costing a lot more than a financial advisor in losses or opportunity costs. It’s important to objectively evaluate your individual situation when deciding whether to manage your own investments.
In this post, we will look at some key questions to ask yourself before you decide to manage your own investments to help make the decision a little easier.
Do you have the motivation?
A person’s success is often tied to their level of motivation or drive to succeed. In fact, researchers have found that motivation influences performance more than intelligence (IQ) over several years. This means that intelligence may be a pre-requisite to investing, but motivation will ultimately determine your long-term success. Successful investors spend a lot of time learning and practicing, which is often referred to as deliberate practice in psychology.
Motivation can come from two sources:
- Intrinsic Motivation: Do you have an innate interest in investing or do you dread math and numbers? Many successful investors are inherently interested in investing to the point that they read finance and investment books in their free time.
- Extrinsic Motivation: Are the costs of using a financial advisor too high? Many financial advisors charge a fee based on your assets under management and managing your own investments can help reduce those fees and open the door to greater earnings.
An investor with a $1 million portfolio might pay upwards of $10,000 per year for a financial advisor, which can amount to a small fortune when you factor in the loss of compounding interest on the fees accrued. While it may be tempting to do-it-yourself to save this money, investors that lack the motivation and neglect their portfolio could end up losing much more than $10,000 per year and may be taking on inappropriate levels of risk.
Do you have enough time?
Managing your own investments can require a substantial time commitment. Our clients trade 12 times a year. How often do you trade?
When building an initial portfolio, you must first determine the optimal asset allocations by assessing your risk tolerance in the context of your financial goals. You must then identify potential investments within those asset categories and conduct due diligence to ensure that they meet the criteria. And finally, you must purchase the investments in one or more brokerage accounts.
After setting up a portfolio, you must also commit to maintaining it on a regular basis to ensure everything is on track. You will need to purchase new securities with any regular contributions, as well as ensure that the portfolio retains the correct asset allocation over time. You may also need to make changes to the portfolio at the end of the year to take advantage of tax loss harvesting while preparing all of their own tax records before filing with the IRS.
It’s important to ensure that you have enough time to tend to these one-time and ongoing needs to avoid any problems. For example, a failure to invest a regular contribution could lead to opportunity costs, while a failure to rebalance a portfolio could lead to excessive amounts of risk.
Do you have the know-how?
Investors should have a baseline level of financial and investment knowledge before managing their own portfolio.
At the most basic level, you need to know the terminology to effectively communicate and execute trades with a broker. You should be familiar with basic asset classes, such as stocks, bonds, and funds, as well as trading terminology like account types, order types, and classes of shares, among other things.
You should also have a basic understanding of how to select investments that fit with your desired strategy. For example, value investors should be familiar with price-earnings ratios and financial statements and momentum investors should be familiar with concepts like moving averages. It’s equally important to understand the impact of expense ratios, commissions, and other fees on your investment performance over the short-term and long-term.
In addition to selecting investments, you should have an understanding of money and portfolio management. This includes things like when to make contributions and how to rebalance a portfolio. Most experts recommend making regular contributions regardless of the market’s performance to benefit from dollar-cost averaging while investing contributions in a way that maintains the portfolio’s optimal asset allocations over time. We offer many free online courses to improve your financial education.
Do you have the right tools?
The right tools can make a big difference when it comes to successfully managing your own portfolio. In particular, you should be cognizant of the various types of brokerage accounts, fund types, and services available to help select the appropriate investments.
For instance, Vanguard points out that a $100,000 portfolio invested over 25 years earning 6% per year with no costs or fees would end up with a value of about $430,000. A 2% expense ratio would reduce those returns to just about $260,000, which is a surprising 40% difference in total returns!
There are many steps that you can take to reduce fees and improve performance:
- Brokers – Brokers charge different levels of commissions and may offer “commission-free” trading in certain funds. You should look at the types of securities you’ll be holding to determine which brokerage account is optimal for your needs.
- Funds – Funds charge different levels of fees depending on their category. You should compare fees when deciding between funds to ensure that you’re paying as little as possible in fees.
- Advisors – Many advisors and research services are designed to help you find the best investments for your portfolio, including Snider Advisors’ service for options. You should evaluate these services as a way to cost-effectively improve your due diligence.
It’s important to note that it’s not always best to go with the cheapest option. You should carefully consider how a broker, fund, or advisor fits within your overall investment objectives and then look at the potential impact of fees within that context.
Do you have the right mentality?
There’s a growing body of evidence that suggests temperament is more important than skill when it comes to investing. In other words, successful investing isn’t that hard if you follow the rules, but most people don’t follow the rules. Are you going to panic when the market plummets or a specific stock takes a downturn and sell? Successful investors take a systematic rather than individualistic approach to investing.
When it comes to active trading, there was a famous experiment conducted in the early 1980s whereby two highly successful traders gave a strict set of rules to about 20 novice traders with little or no experience in the market. The so-called Turtle Experiment was a huge success and demonstrated that anyone could be successful if they stuck to the rules and didn’t let emotion get in the way of effectively trading and investing.
When it comes to passive investing, Warren Buffett made a famous $1 million bet back in 2007 with Protégé Partners that the Vanguard S&P 500 index fund would beat five hedge funds selected by the asset management firm over the next ten years. Buffett is overwhelmingly favored to win the bet, which demonstrates that many investors are tempted to try and time the market rather than stick to a basic strategy that works.
The Bottom Line
Successful self-directed investors have the right combination of motivation, knowledge, tools, time, and temperament. While this may seem like a lot to handle, there are many benefits to managing your own investments, including lower costs, better returns, and more control. You should carefully consider all of these factors when deciding whether to manage their own investments or outsource it to a professional advisor or asset management firm.
