Should You Be A DIY Investor?

March 07, 2018

Should you choose your own investments or have someone else do it for you? It’s a choice that every investor has to make. Let’s take a look at the pros and cons of do-it-yourself investing: 

Pros 

  1. It can be cheaper. You avoid advisory fees and you can choose low cost funds or even avoid fund fees entirely by investing in individual stocks and bonds. This is important as minimizing fees is one of the surest paths to investment success. In fact, a study of various asset allocation strategies found that fees mattered more than which strategy you chose in determining your performance.   
  2. You have more control. Having someone else choose your investments can mean giving up some control. If you are very particular about your investment strategy or want to avoid investing in certain companies or industries for moral reasons, you may be reluctant to give up that control. 
  3. It can be fun. Many people prefer to manage their own investments because they actually enjoy it. This is especially true for more speculative and “hands-on” investments like individual stocks, direct real estate, and more recently, cryptocurrencies. 

Cons 

  1.  It can also be more expensive. Most of the costs of investing are relatively hidden and don’t show up on your statements or trade confirmations. Mutual fund expense ratios are generally buried in the fund prospectus and turnover costs aren’t reported at all but can have a significant impact on your returns. 
  2. You have more control. More control isn’t always a good thing. Some of the most common mistakes investors make include chasing past performance, not being properly diversified, holding on to losing investments too long in the hope that they recover, and paying more in taxes than you need to. At the very least, it can be helpful to have a second opinion. A Vanguard study found that a good financial advisor can save you about 3% a year (net of a 1% advisory fee) in helping you avoid bad decisions. 
  3. It can be time consuming and stressful. Even if you are good at managing your investments, you may not have the time or desire to manage them yourself. Your time may be better spent elsewhere. 

How to get started 

Let’s say you want to be a do-it-yourself investor. Where do you start? Here some tips: 

  1. Have a strategy. You don’t want to just pick whatever happens to be doing well at the time, your brother-in-law’s recommendation, or what “feels right.” Instead, you might want to start by taking a risk tolerance questionnaire like this one and follow the guidelines as to how much to invest in stocks vs bonds vs cash (known as your “asset allocation”). You can also check out these asset allocation models by the American Association of Individual Investors and these “lazy portfolios” put together by various investment experts. Once you’ve decided on a strategy, consider putting it in writing.  
  2. Keep your costs low. Remember that study that found that fees can be more important than your asset allocation strategy? To keep your costs low, consider Warren Buffett’s recommendation of investing in index funds, which tend to have very low fees and turnover costs. By using index funds, you also avoid having to choose an active fund manager, which can be a notoriously difficult choice to make as most underperform the market index (which is what index funds track) and those who outperformed in the past are no more likely to do so in the future. If you don’t have index funds available to you, look for funds with the lowest expense and turnover ratios in their category. 
  3. Consider individual securities. Another way to minimize costs is to avoid fund fees altogether and purchase individual stocks and bonds. (Just be careful of commissions and other trading costs.) To be diversified, make sure you have at least 20-30 different stocks from a variety of sectors and with no more than 10-15% in any one stock. You can use a free stock screener to help you find stocks that meet your criteria. If you don’t know what criteria to use, you probably shouldn’t be picking individual stocks. Don’t worry though. As we saw, most professional investors fail to beat the market so you probably won’t either and would likely be better off with simple index funds.   
  4. Don’t gamble with your retirement or college funds. Your retirement and college funds should be in a boring, diversified, low cost portfolio. If you insist on wanting to “play” the stock market or gamble on Bitcoin, consider doing so only with money you can afford to lose…or just take that money and go to Vegas. You’ll probably have more fun that way.