Do It Yourself (DIY) or Outsource Investments?
I've met with many people who are unsure whether they should try to self manage their investments or hire a professional. As an investment advisor, my aim is to help empower those who'd like to tackle this endeavor while being honest about what it takes to do so.
Managing your own portfolio (and managing it well) requires a few important components in order to achieve a better outcome than paying someone else to do it for you. If you don’t possess the components, the value you’ll receive from a professional who understands your situation will likely far exceed the cost over your lifetime. So what if you're wanting to manage your own portfolio? Do you have what it takes to do so successfully?
Investing and Gym Memberships
Investing today is a lot like joining a gym. You can join the gym for a low monthly fee and research the best workout program to accomplish what you are setting out to do. Then you implement on your own. But if you don't think you'll implement on your own, or if you want to make sure things are done correctly, or if you want to accountability to achieve your goals, you are going to hire a personal trainer.
There is another option now as well -- robo advisors. Robo advisors are a digital platform that manages your portfolio for a lower management fee than a human advisor. To continue the gym analogy, a robo advisor would be like a fitness class. It's still on you to get yourself to the class in the same way that it's still a DIY investor's responsibility to save and invest their cash. But once you are there they will give you guidance (albeit impersonal).
With a robo advisor, you won't have a program that's personalized to your health needs or the accountability to do what is required outside of the class, but for a self motivated person it can be a great option. Therefore, I consider the ingredients required for DIY investing to also be relevant for investing with a robo advisor since it's still a largely a self directed approach.
The Ingredients You Need to Self-Manage Your Investments
So how do you determine whether you “have what it takes” to invest on your own? There are three ingredients required to self manage your portfolio: Time, Interest, and Discipline. If you don’t have all three, then you have a slim chance of doing better than a professional.
Time — You have to dedicate the time to develop a strategy and maintain it. If you aren’t willing to dedicate the time to read a few books to understand investing (like Random Walk Down Wall Street, The Investor’s Manifesto, The Four Pillars of Investing, The Investment Answer) then you don't have the time to self-manage. This is your life savings we are talking about here. The stakes are high, and if you can’t make room in your schedule to understand investing or how to develop a investment strategy that is personalized to your situation and goals, then you may not be well suited for self management. All investment strategies go through periods of "underperformance." So even if you use a robo advisor, you still need to understand and be convinced of the strategy because it will be up to you avoid the fatal mistake of abandoning it during the rough patches.
You also need to consider the opportunity cost of your own time. Could you be spending the time in another way that’s more fulfilling and enriching to your life? Could you be spending it with family? Could you be spending time on things that will further your career or help increase your income? I have many clients who are capable of self managing, but would just rather spend their time on other things that are more important to them.
Interest — You won’t dedicate the time to reading and understanding investing unless you have an interest in the subject. You need to make smart decisions. Those smart decisions will be a result of a curiosity and interest in the subject matter that will drive you to the right answers.
Many DIYers are willing to sacrifice their time to save money, but if you don’t have an interest in the investing, you won’t develop the skills and knowledge base required to produce a better outcome for yourself than hiring a professional.
Discipline — This is where the rubber meets the road and requires you to be completely honest with yourself. Investing is a wild ride. Your portfolio is going to bounce up and down, and you will constantly be bombarded with scary headlines designed to elicit an emotional response from you. Do you have the discipline fight off your cognitive biases in order to make smart choices? It's not a matter of intelligence -- it's a matter of being human.
Investing requires you to act in a way that is contrary to your emotional impulses, and usually in the exact opposite way. When the financial world seemed to be ending in 2008-2009 and you felt like throwing up, were you a buyer or seller or neither? If you weren't a buyer, you may not have the discipline required to make the cold and calculated decisions in the face of uncertainty needed to achieve the best outcome. Undisciplined DIY investors who didn't rebalance into stocks during that period could have paid a very high investment management fee over the last 10 years and still been better off today.
Investor behavior has an enormous impact on returns -- more than fees/expenses and more than fund/security selection. So when the market is “expensive” will you be sitting on your cash or continue to invest it prudently? When the markets become volatile, will you still rebalance against the advice of scary headlines? Do you have the discipline to carry out a strategy through thick and thin? The research has confirmed over and over again, investors make terrible timing decisions. Dalbar’s famous study demonstrated that due to poor timing decisions, the average investor underperforms their own investments by on average 3% per year.
Whether it’s because of sitting in cash too long, or selling out of stocks to cash when things get scary, it’s easy to make a reactive investment decision that severely impacts your returns in a negative way. In order to invest your own money, you need a heavy dose of discipline. Otherwise, you're better off with an advisor who acts as an objective guide for you through turbulent markets to ensure you make the right decisions and avoid damaging investment mistakes.
DIY Investment Risks
As with certain DIY projects around your home, there are certain risks of tackling something on your own. You may conclude that the risks are worth taking, but it’s important that you and your spouse understand them and are both on board.
There are many things in life that you can successfully DIY. Fixing your kitchen sink, for example, is fairly low-risk. The potential risks of what could go wrong should influence which projects you choose to tackle yourself. If you mess up your sink, it likely won’t be very expensive to fix.
However, with investing there is an enormously high cost of making a mistake regardless of your portfolio size. A mistake that costs you $10,000 at age 40 ends up being a $728,000 mistake by age 85 if that $10,000 grew at 10% per year for 45 years. That’s the difference between having a financial legacy to pass on to your children and having to financially depend on your children to take care of you.
Therefore, DIY investing is more like a DIY roof replacement than a sink replacement. Even if you have the Time, Interest, and Discipline to tackle the project, you are still putting yourself on top of a roof and could severely injure yourself. Be aware of the risks you are taking on, and make decisions carefully.
How Many People Have What it Takes?
William Bernstein, a former brain surgeon turned author of several investment books left the medical field in order to educate investors. He has dedicated his life to empowering people to manage their own investments. However, Bernstein ultimately realized that while he possessed all of the ingredients to self manage, most people do not.
Advocating for people to self-manage their investments is like advocating for people do to all of their own car repairs and maintenance — there are a certain percentage of people who can and will, but a majority of people will achieve a better outcome by hiring a skilled mechanic who does it all day and has the necessary tools to do so.
You can do it yourself, but it’s difficult, and I think the 1% estimate is probably about right (of people who have what it takes to self-manage). I came up with actually a theoretical estimate of around one one-hundredth of 1%, but that may be off.
— William Bernstein, M.D.
When it comes to self managing your investments, the key is to be honest with yourself. If you have what it takes, you have the opportunity to save a lot money over time by doing it yourself (assuming you do as well as a professional). In the same way, you could save a lot of money doing your own car repairs, but it's all for nothing if you make a mistake that causes you to lose control of the car while your kids are in the back seat. The stakes are high.
If you have any doubts about whether you possess the ingredients to success, the value you receive from a skilled financial advisor will far outweigh the cost of hiring one. Since the cost of making financial mistakes is so high, my hope is that this post has helped you determine for yourself whether or not you should to pay a professional to avoid them.