Common Mistakes of Do-It-Yourself Investors
I am all for doing it yourself. I like the feeling that I get when accomplishing small tasks around the house. But I definitely know my limits. And I don’t kid myself that just because I can, I should. Just because you can buy the tool, doesn’t mean you should use it.
Similarly, that would-be-handyman adage can also be applied to finances. Just because you can create your own portfolio, doesn't mean you should. And most do-it-yourself, or DIY, investors definitely shouldn't manage it.
Unfortunately, many financial do-it-yourselfers don’t heed that advice.
As I've discussed previously, the average investor's choices have consistently under-performed year over year. The main culprit for the lack of solid DIY financial success is emotional investing; that is, allowing emotions to guide investment decisions.
What leads to emotional investing? While all investors and their needs are unique, there are some common factors that lead an average investor to abandon a well-thought out strategy and succumb to emotional money choices.
Start, and stick with, a strong plan
To create a sound investment strategy that lasts throughout the ever-changing market and economic cycles you must:
- Set realistic expectations for the rates of return needed from your portfolio to meet your long-term financial needs;
- Educate yourself on the risks involved, including volatility, in attempting to achieve this return;
- Understand your personal tolerances to the normal volatility that you will experience in this portfolio; and
- Develop a strategy to keep yourself on course as your investments, markets, and economies shift.
Most DIY investors stray from this course almost immediately.
While they consider the rates of return that they desire, they rarely link those rates to their actual needs. Instead, the average investor looks to the most popular or recently successful investment strategy upon which to peg their desired return.
Take, for example, an investor with a financial plan that dictates current and future investments must return a rate of 6 percent per year to meet or exceed goals in a predictable manner. Rather than looking for vehicles to achieve that 6 percent annual return, the emotional investor tends to end up with an allocation that is mismatched to the investor's goals and risk tolerance level.
An inappropriate risk-to-goals match inevitably leads to disappointment, either in lack of return or higher than expected volatility. In either situation, the average investor will attempt to adjust by making an ill-advised emotional decision.
Avoiding ill-advised emotional moves
To make up for lower than expected return, the investor increases the percentage of investments to the asset class that provided the highest recent return. Where volatility is greater than the investor expected, the investor usually looks to reduce risk by selling perceived under-performers. Both of these market timing strategies have proven ineffective.
A dedicated and experienced wealth management team can help investors avoid such costly emotional decisions.
Conversely, an experienced investment professional will promote, and provide for wealth management and retirement plan participants, a strategy that both meets their need for investment return and best fits their psyches. It takes frequent self-checks as the markets cycle, but having this strategy in place is a solid base.
Qualified wealth managers also help clients to understand that investment vehicles like stocks, bonds, mutual funds, and the like are simply the tools used to build a solid investment strategy. Before picking up those tools, ask yourself, do I really know what I am building?
With the guidance of a wealth manager, you can be sure the construction will be sound.