Scott Hansen, BridgeTower Media Newswires
There is an ever-increasing list of resources for investors seeking advice, including financial advisors or brokers, wealth managers, and estate and financial planners. However, quite a large number of investors feel that self-management of their investment portfolio makes sense for them. This requires a great deal of time and effort to determine what information is important and what is not, while avoiding the fear and greed of the market. For many reasons, this role is best filled by a highly skilled and trained financial manager.
If one chooses to forgo a financial manager, the DIY approach to investing involves selecting your own investments and their allocation, making changes based on ongoing evaluation and constantly monitoring the health of the economy and market reactions to it. Most importantly, it should include sticking with the long-term plan.
Every day media sources barrage us with information from thousands of sources, both credible and not. Any one mistake made from inaccurate information can derail a plan for many years or even make it fail completely. A professional can ignore all of the useless information out there, while taking advantage of the market changing data points and applying them in the right way to benefit the plan.
Risk management is a major component of any financial plan, and a non-professional is prone to make potentially costly mistakes in this area. There are many types of risk that an investor must manage that can greatly impact their portfolio.
Market risk is the most obvious type of investment risk. Market risk is the risk of an investment declining in value because of developments in the economy or other events that affect the entire market. However, there is also liquidity risk, concentration risk, credit risk for fixed income portfolios, reinvestment risk, inflation risk, interest rate risk, business risk and, for some, currency or foreign exchange risk to consider.
This is a complex set of factors to learn about and monitor on an ongoing basis. While there are many ways to examine portfolio risk, it does take a professional level of expertise to manage all of these extremely complicated factors. It is surprising how many investors have already forgotten how ugly the impact of 2008 was on their bottom line and have put risk management on the back burner as the market churns higher as it did in 2017.
Market timing is one of the most serious mistakes made by the self-investor. Even those investors taking advice from a professional are prone to thinking that calling a market top or bottom is easy and will only affect the portfolio in a positive way. This is largely because the DIY investor will often equate the market with the economy in general. While there are times when the market does move in step with the economy and it seems easy, the equity and fixed income markets are also futures markets. In those instances, the markets are looking ahead for certain data points or even to a downturn in the economy before it becomes obvious.
The effect of market timing on a portfolio can be substantial; making ill-conceived market moves can reduce the growth of one’s investments significantly. The chart below graphs the growth of the S&P 500 Index from 1999 through June 30, 2015. The blue line displays the growth of $10,000 that remains fully invested in the S&P 500 Index over the entire time period. The yellow line shows the same growth but excludes the top 10 return days over the 25-year period. By missing the top 10 return days over that period, the end period value grows only to half the value of the blue line that represents remaining fully invested.
DIY investors seem to forget that market timing involves making two decisions: when to sell and when to buy. Making both of these complex decisions at the right time on a consistent basis is impossible.
Self-investors are often paying fees they don’t understand and some they may not even know about. An important reason for investors to build a relationship with a trusted advisor and stick with them are the fees paid for that advice. The DIY investor is often piecing together information from a variety of cheap and questionable sources and paying a great deal for it. The professional advisor usually has a dedicated team of research analysts and traders working diligently on the performance of that portfolio. The client knows where the information comes from and can see the results of that information firsthand and knows exactly what they are paying for. The DIY investor often does not fully understand the fees they are paying to self-invest. Many investment products have hidden fees charged at the purchase or sale, but also during the holding period. For example, there are custodial fees, inactivity fees, expense ratios and access fees for differing levels of investment research.
Without question, investing is an emotional experience. It has been said for decades that the two things that move any market are fear and greed. While a strong argument can be made in favor of that being true, the market can take the investor on a wild roller coaster ride of emotions. This was never more evident than during the financial crisis of 2007-2008. Clearly a 40% pullback in the equity market is an extreme example, but an investor who let emotions rule and left the market during that time clearly paid a price and did not fully participate in the recovery that has occurred in subsequent years. The self-investor is more likely to overreact to a market move, either buying in euphoria as markets make new highs or selling during a necessary pullback in prices. These can be costly mistakes.
DIY may seem like an attractive option for those looking to save money, those who believe they are smarter then the professionals, and those who have nothing else to do (retired). However, studies have shown the track record for self-managed, individual investors is not encouraging.
Consider this scenario from Investopedia:
DALBAR, a leading financial services marketing research firm, released a study that showed from 1990 to 2010, the unmanaged S&P 500 Index earned an average of 7.81% annually. Over that same period, the average DIY equity investor earned a paltry 3.49% annually. The difference in wealth accumulation between these two numbers is staggering. Over 20 years, a $100,000 investment would grow to nearly $450,000 if compounded at 7.81%, while a $100,000 investment would grow to only $198,600 if compounded at 3.49%!
It’s important to note that the performance differential had little to do with the returns of the average equity mutual fund, which performed just shy of the index itself, but was most affected by the fact that investors were unable to manage their own emotions and moved into funds near market tops while bailing out at market lows.
The bottom line is: DIY investors should build a relationship with a trained and skilled investment professional who knows how to communicate investment advice at the right level, construct a long-term plan and stick to it. This will allow the DIY investor to become a client and enjoy the results of their carefully managed plan when it comes time to retire.
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Scott Hansen is a vice president for Karpus Investment Management, Florida Office, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534, phone (585) 586-4680.
