Pros And Cons Of Do-it-yourself Investing
By Mary Rowland
One of the first questions investors ask is this: Should I invest on my own or get the help of a financial planner?
For many investors, the answer is an obvious one. If you receive a large inheritance or divorce or insurance settlement and have no knowledge of the markets, you need help. But what about the rest of us? We know a little bit. We're willing to learn more. We're intrigued by the idea of investing. But will we do a good job?
There are pros and cons to doing your own investing. I count five of each. Weíll start with the disadvantages.
1. You don't know how to design a portfolio. When investment advisers -- the best of them -- design portfolios, they talk about the "efficient frontier," or a string of portfolios stretching along a line of increasing risk. In other words, there is a portfolio that most efficiently matches your level of risk. A person with a high level of risk would have a much different "efficient frontier" than a person who canít stomach the idea of losing money even for a few days in exchange for the possibility of higher returns in the long run. Each efficient portfolio on the frontier provides the greatest possible return for the risk itís taking. Designing them is part science, part art. Itís not work for a novice.
In his investment classic, "Asset Allocation," money manager Roger Gibson says that "a portfolio that minimizes portfolio risk for a given expected return (or maximizes portfolio expected return for a given level of risk) is said to be efficient. If we join together all the efficient portfolios for a given set of investment alternatives, we form what is called the efficient frontier." The plannerís job is to assess your level of risk and then design a portfolio that provides the highest possible return for the risk youíre willing or able to take. Some planners, such as Eleanor Blayney in McLean, Va., actually move clients along the frontier, adding a bit more risk for a bit more return as they feel comfortable with investing.
2. You are emotional about your investments. Economists and psychologists who study investing identify all kinds of ways that we are irrational about our money. We second-guess ourselves. We fear regretting a bad decision. We hate to lose more than we love to win. All of these things cause us to make bad investment decisions. But you don't need an economist to tell you this. You probably know about your own money quirks. Perhaps it's the thrill of the hunt for stocks, the rush you get if you make a good investment or the guilt you feel if you spend too much. Or perhaps you're just frozen with fear at the idea of investing at all. All of these emotions are bad for investing. The efficient frontier doesn't take emotions into account. Financial planners pick a spot for you on the efficient frontier, goad you into taking the required risk to get on it and then cajole you into hanging tight.
3. You don't have the time. Creating and monitoring an investment portfolio can be time-consuming. It's difficult, too, to figure out your own investment performance as opposed to that of the funds you invested in. Look at what happened to the Beardstown Ladies, who sold 80,000 books by claiming an average annual return of more than 22% when they actually got just over 9%. There is a piece of good news here. Steve Norwitz, a vice president at T. Rowe Price Associates, says that the latest trend in fund statements is to give you performance numbers for the fund since you owned it, which will make that easier.
4. You lack discipline. A planner will tell you exactly how much you must save to meet your goals. He'll probably arrange for the money to be automatically withdrawn from your bank account or paycheck. So you'll be saving and investing whether you want to or not. You'll reach your goals, too. On your own, you might not even get started.
5. You lack staying power. When the going gets rough in the market, do you get going -- out of the market? Studies show that most individual investors do much worse performance-wise than the funds they invest in. That's because they trade in and out rather than sticking with them.
Now five advantages to doing it yourself:
1. You save a lot of money. A typical fee for a financial adviser is 1% annually of your assets. That's a lot. But you might pay even more if you choose funds with high annual fees and back-end loads. You could afford to make a few mistakes and still come out ahead.
2. You can get the same performance. A portfolio on the efficient frontier probably won't beat a good balanced fund. Financial advisers hate to hear this but it's true. If they're doing a good job, they're diversifying your portfolio and limiting the risks you take. A good adviser doesn't try to shoot out the lights. That's the same thing a balanced fund does. You could probably do just as well with the Vanguard STAR fund (VGSTX), a fund made up of seven other Vanguard funds, as with an adviser. Or with Dodge & Cox Balanced (DODBX), for that matter. You could also consider investing in index funds like Fidelityís Spartan Equity Index (FUSEX) or Vanguardís 500 Index (VFINX). Index funds donít offer the diversity, but they have passed the test of time.
3. Investing can be satisfying. I think here of Scott A. McMillan, a frequent participant in our newsgroups. I think Scott truly loves to learn about investing. He reads everything he can get his hands on, asks questions, checks himself and compares one investment to another. I can't imagine Scott using a financial adviser. I can imagine Scott being a financial adviser.
4. You can manage and control taxes better. If you manage your own portfolio, you can offset capital gains with capital losses. You can also buy individual stocks that don't throw off dividends if you like. Most mutual fund managers don't care about taxes. They care about showing good quarterly performance figures, whatever it takes. And with Internet-based investment sites, such as the Investor section of MoneyCentral, you can easily track your investments and stay abreast of the markets ups and downs.
5. Potential performance is higher. Perhaps you don't know how to design a portfolio on the efficient frontier. Well, you don't have to. If you do it yourself, you can take on a risk profile that an investment adviser would never set up for you.
For example, suppose you say to an adviser: "I want to buy five stocks that will double in five years. Please find the five fastest-growing tech stocks, buy them and monitor them for me, keeping my money always in the top five." A top adviser would say: "Go somewhere else. That's not what we do here." But you could try that yourself. When you manage your own money, you can take as much risk as you like, recognizing, of course, that you could lose big.