Managing your investments can feel like an overwhelming (or boring) task to many people. There are a lot of important decisions that need to be made.
How much to invest
What to invest in
Deciding on the right asset allocation
Knowing when you’ve invested enough (when you’ve reached Financial Independence)
How to handle market downturns
Knowing how to live off your investments in retirement egg
These are just some of the decisions investors are faced with. Making the wrong decision can have significant consequences for your finances. There are three ways you can choose to manage your investment portfolio:
Do it yourself (DIY)
Hire a financial advisor
Use a Robo-advisor
Let’s review the pros and cons of each to determine which is the best fit for you.
If you plan on managing your own investments you will have one obstacle you need to overcome; yourself. Humans are an emotional mess and the way our brain is wired makes us terrible at making investment decisions. Whatever your instinct is when it comes to investing is probably wrong.
You may think it’s a good idea to pick individuals stocks. There is a mountain of research that suggests that is a bad idea.
If picking stocks yourself isn’t a good idea then perhaps you should pay a mutual fund manager to pick them for you?
Again, research suggests that is a bad idea too. If we accept that the stock market is relatively efficient than investing in actively managed mutual funds will not give you the optimal outcome. You’ll pay higher fees with a small probability of “beating the market”.
If we accept the stock market is relatively efficient than the logical way to invest in the stock market is through low-cost index funds. There is one problem solved.
However, even if you choose to invest in index funds there are still a lot of decisions to be made.
Do I invest in foreign or domestic stocks?
How much do I allocate to bonds vs stocks?
Which specific funds should I invest in?
Each decision provides your brain the opportunity to make the wrong choice. Morningstar released research that showed DIY investors underperformed the funds they invested in by 1% per year.
The funds in the study had an average return of 7% per year but DIY investors only had an average return of 6% per year.
How could this be? Put simply the DIY investors followed their instincts, which of course, were wrong.
They bought high and sold low. Not what you want.
Action item: If you are a DIY investor or are thinking about it, try out this free compound interest calculator to see how much wealth your investments might generate over time.
DIY investors should embrace simplicity
The best way to ensure a positive outcome is for DIY investors to put themselves in a position where they need to make as few decisions as possible.
That is why I am a fan of what are called “one decision portfolios”. These funds provide a balanced investment portfolio of internationally stocks and bonds. By investing in a one decision portfolio you do not need to invest in multiple different funds and have to worry about rebalancing your portfolio.
You simply choose which fund you want to invest in based on the fund’s allocation to stocks and bonds that fit your objectives. After that, the only decision you have to make is how much you need to save each month.
The Balance (no pun intended) put together a list of one decision funds here.
Hiring a financial advisor
If the idea of managing your own investments stresses you out perhaps you should consider firing a financial advisor to do that for you. Financial advisors typically get paid in one of two ways.
They take a percentage of the investments they manage on your behalf. This is referred to as the Assets Under Management (AUM) model.
They charge a flat, hourly or retainer fee. This is referred to as the fee-only model.
If you go the financial advisor route its important to do your homework and shop around first. Different advisors provide different levels of service. Some advisors will simply manage your investments while others will draw up a detailed financial plan.
Make sure you know what you are paying for and what the market price is for those services to ensure you don’t overpay.
When it comes to working with a fee-only or AUM financial planner, personally I feel more comfortable with a fee-only planner. For the simple reason that their economic incentives are aligned with your own.
A fee-only advisor gets paid for giving financial advice.
An AUM advisor only gets paid when you invest.
The more you invest, the more they get paid. If you invest in certain funds, they get paid more. This gives advisors the incentive to always encourage you to invest more or invest in a particular fund, even if it is not the optional decision.
If you choose to work with an advisor the most important thing is you endure you choose an advisor who you can trust and feel comfortable work with.
If you don’t want to manage your investments on your own but can’t afford a financial advisor you could always consider a Robo-advisor. A Robo-advisor is almost a hybrid between DIY investing and working with a financial advisor.
A Robo-advisor is an online platform t provide automated, algorithm-driven financial advice. These platforms often have little to no human interaction.
After answering a series of questions and inputting your financial information, the Robo-advisor will use an algorithm to suggest a diversified portfolio based on your risk preferences, goals and individual circumstances.
Robo-Advisors typically cost a fraction of what a traditional financial planner costs and can help someone with no investing experience construct a diversified portfolio in a single day.
Like with human advisors, it’s important to do your homework and research different Robo-Advisors to find the one that fits your circumstances. Investopedia has put together a list of the most popular Robo-advisors and listed the pros and cons of each.
Whether you want to be a DIY investor, work with a human or Robo-advisor there is no shortage of options and information on managing your investments. In a way that is part of the problem, when there are too many options or too much information it’s easy to suffer from decision paralysis.
For those truly interested in learning to invest their own money and have the emotional fortitude to not make decisions based on fear, DIY investing may be a good option. If you choose to manage your investments yourself, it’s important to minimize the number of decision you need to make.
If you have a substantial net worth and assets to invest working with a human financial planner can lead to an optimal outcome.
If you aren’t comfortable investing your own money and you don’t have a lot of assets to invest or money to pay a human advisor, a Robo-advisor might be the right choice for you.
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