August, 2009
The Second Opinion: Should You Do-It-Yourself?

Do-It-Yourself Investing

The market meltdown has many investors questioning the investment advice they receive from their advisors. The advice has not protected them from the market downturn. In fact, often times, the advice included risky strategies like leveraged investing which simply increased losses. This has caused many investors to ask ‘should I manage my portfolio myself?'

This issue of The Second Opinion will explore the issues surrounding this question. In particular, we will explore the pros and cons of DIY investing and discuss how Second Opinion can help DIY investors. We also present Warren MacKenzie’s tip ‘define your role in managing your investments’.

Pros and Cons of DIY Investing

Cons

  1. Time is Money: Even though DIY investing usually costs less than working with an advisor, it will likely take up more of your time. This is because you have to spend time learning about finance and economics as well as performing mundane administrative tasks such as portfolio monitoring and rebalancing.
  2. Knowledge Gap: This is less of a consideration than most people would think. You do not need a degree in order to manage your portfolio yourself, but you do need to know about passive investment options and how to set an appropriate asset allocation. With the help of a knowledgeable professional pointing you in the right direction, this may not take long at all. There are also many free tools and educational content on the internet to help you along.
  3. Fear / Concern: Some people may be overly scared or concerned. Managing their portfolio is an unknown, and given its importance, they feel more comfortable having a professional looking after it for them. Those who cannot get over this fear probably should not do-it-themselves.

Pros

  1. Performance: Index mutual funds and Exchange Traded Funds (ETFs) allow you to achieve the market’s return with little burden or monitoring required. Since less than half of the investment professionals achieve better results, your performance will certainly be up to par.
  2. Cost: This is perhaps the simplest pro to understand – the less money you pay to your advisor or investment manager, the more money you have left over for yourself! And the amount can be staggering! For example, an investor with $500,000 to invest that achieves a gross return of 7% but pays a 2.5% fee to their advisor will have about $776,000 after 10 years. If the same investor did-it-themselves and incurred costs of only 1% per annum they would have $895,000 – a difference of $119,000.
  3. Increased Sophistication: By doing-it-yourself, you will invariably have to learn about the basics of investing and the various investment options that are available. This will lead to an increased sophistication on your part, and may very well help you make day-to-day financial decisions more easily.
  4. Peace of Mind: Quite often investors who use advisors experience anxiety because they do not understand their portfolio. Contacting their advisor is little help because the advisor talks in jargon that is meaningless to them. By doing-it-yourself, your increased sophistication from your research and the fact that you are ‘on top’ of your portfolio will reduce or even eliminate this feeling of anxiety and replace it with peace of mind.
  5. Help for DIY Investors: A ‘do-it-yourself’ investor getting outside help sounds a lot like an oxymoron, but it is not. DIY investors will likely require help in creating an Investment Policy Statement (IPS) complete with a strategic asset allocation. They may also need help on other portfolio set-up issues and even on financial education. There are many on-line tools to provide this help. Second Opinion can also help in this area. The great thing about these sources is that they tend to be much less biased than a financial advisor who sells investment products.

In short, DIY investing is a good option for individuals who want to match the market’s return and generally participate in the growth of the economy. It is not for investors who have the desire to ‘beat the market’.

Carlo Palazzo, CIM

Define Your Role in Managing Your Investments

To get the best results it is important to understand your strengths and weaknesses and to define the role you will take in the investment process. Do-it-yourselfers may decide to take on all of the roles, including analyzing their investments, managing their portfolio, and trading their securities. Others who work with an investment advisor might share some of these roles with their advisor. Still others will delegate all investment decisions to a discretionary money manager or investment counselor. The role you choose depends on your level of interest, involvement, skill, and experience.

With the advent of online trading, instant portfolio valuations, multiple investment options, and online help from experts, managing your investments has never been easier, and is a sensible choice for many. The second choice is to work with a financial advisor who in most cases is a commissioned salesman. The third choice is to delegate all of the investment decision-making to a discretionary portfolio manager or investment counselor. For a fee they will take full responsibility for professionally managing your investments.

Investors can be divided into four groups based on knowledge and level of involvement:

Knowledgeable and involved investors

These are investors who have the knowledge, time, and interest to look after their investments themselves. They may be working with an advisor, but could easily do-it-themselves. Those working with an advisor often enjoy the relationship and like to have someone to discuss the markets with. They are on an even footing with the advisor, so they understand, and can properly evaluate, any investment recommendations given to them. They could move their money to an investment counselor where it would be managed professionally on a discretionary basis, but they might miss the action. These investors can select from any of the three choices. Those who decide to manage their investments themselves or to work with an advisor should realize that in retirement their first objective should be to meet their financial goals, not to enjoy their hobby.

Knowledgeable and uninvolved investors

These investors are knowledgeable about the market but choose not to take an active interest. They might be traveling, or busy with work or family, or they have just lost interest. For some retirees, illness may mean that they are not able to properly attend to their financial affairs. Those investors who want to go it alone or work with an advisor should simplify their investment portfolio with a few well-chosen ETFs or mutual funds. With a simpler portfolio, the need to use an advisor diminishes, but it still may make sense to continue the relationship. Other knowledgeable investors may decide it makes sense simply to move their funds to an investment counselor and delegate all of the responsibility to a qualified professional.

Limited knowledge and involved investors

Typically this type of investor is new to investing, wants to learn, and wants to get involved. Everyone has to start somewhere, but it is foolish for these novice investors to take the do-it-yourself route. However, having your money managed by a professional, like an investment counselor, does not give you a chance to be involved or to learn. For this reason, working with an advisor is a good place to start. When looking for an advisor, trust is one of the most important factors. Because your lack of knowledge puts you at a disadvantage in the client/advisor relationship, you need an advisor you can trust. Keeping the investing simple will help you understand what you are doing. The advisor should be willing to explain and educate you to some degree.

Unknowledgeable and uninvolved investors

These investors, especially if they are seniors, make vulnerable targets for the unscrupulous. This is especially true for recently widowed seniors, who are not only coping with grief, but also with managing all of the finances. If they do not have the investment knowledge or interest, they are forced to trust those who are advising them. These investors are sitting ducks for an unethical advisor, and are at a disadvantage even when dealing with a well-intentioned advisor. This makes it vital to have an advisor who you trust totally. In many cases, if they have sufficient funds, these investors should simply hire a discretionary money manager or investment counselor to manage their portfolio.

What you can do now:

  • Recognize that the being a good client – setting realistic goals and assuring that they are met - is the most important role you can take.
  • Do an honest evaluation of your skills and knowledge as an investor.
  • Determine how involved you want to be in managing your investments.
  • Evaluate your current role and determine if a different approach might be more suitable.

Bottom line:

It is important for investors to recognize their own strengths and weaknesses. This will help them decide whether to manage their investments themselves, work with an advisor, or delegate the investment decisions to a discretionary portfolio manager or investment counselor. It is possible for all investors, even those with limited investment knowledge and interest, to have investing success if they properly delegate their investment decisions.

How Can Second Opinion Help DIY Investors?

SOIS helps DIY investors in several ways:

  • Educational Content: SOIS employees create a lot of educational content for investors. These include Warren MacKenzie`s books, Ken Hawkins` articles, and this newsletter.
  • Investment Tools: Our website has many tools for the DIY investor. These include a rate of return calculator and also a tool for comparing your performance against a benchmark. There is also a self assessment quiz to test your investment knowledge.
  • DIY Coaching Service: SOIS also offers a coaching service for DIY investors. In this service you will get a financial plan which shows you what average rate of return you need to achieve your goals. We will then provide a strategic asset allocation that is likely to achieve that target rate of return. This asset allocation is used to create a customized Investment Policy Statement (IPS). With these three pieces of information it is possible to implement your portfolio. We top it off with a binder full of educational content, a quarterly phone call from a consultant to discuss the portfolio, and an annual review.

The greatest value of the DIY service is that it helps clients stay focused on the investing process rather than chasing after investing products.

As an example of the high level educational content our DIY clients receive, here is a short over view on bond ETFs from our Vice President, Ken Hawkins (the discussion and analysis represents the “meat” of the document and is only available to our DIY clients).

Bond Exchange Traded Funds (July 31, 2009)

Quality Breakdown
ETFs Ticker MER Average Duration Average YTM AAA & AA A BBB and Below
Universe
iShares Bond Universe
  XBB 0.30% 6.0 3.4% 74.5% 18.9% 4.9%
Credit
iShares Government Bond
  XGB 0.35% 6.3 3.0% 86.6% 12.1% 0.0%
iShares Corporate Bond
XCB 0.40% 5.1 >4.1% 47.8% 32.2% 18.5%
Term
iShares Short Term Bond
  XSB 0.25% 2.8 2.4% 83.4% 10.6% 4.5%
iShares Long Term Bond
  XLB 0.35% 12.5 4.9% 60.2% 32.1% 6.2%
Laddered Bonds
Claymore 1-5 Yr Corporate Bond
  CBO 0.25% 3.0 N/A N/A N/A N/A
Claymore 1-5 Yr Government Bond
  CLF 0.15% 3.2 N/A N/A N/A N/A
Other
iShares Real Return Bond
XRB 0.35% 15.8

1.8%

91.8%

7.9%

0.0%

Claymore Premium Money Mkt
  CMR 0.25% N/A N/A N/A N/A N/A