I do OK around the house but I wouldn’t describe myself as a handyman. That never stops me from trying of course. Last week when it was snowing and dark outside, I carried the big ladder up the small ladder, set it up on the roof, and then climbed to the top step just to change an exterior light bulb. I could have waited until daytime. I could have waited until the snow on the roof melted. I could have called my neighbor to come help. But that’s when I had time to do it, so that’s when it was going to get done. I’m not proud of it. Ok, I’m a little proud of it…
People engage in high risk/low reward activities all the time, particularly with their investments. Many are fully capable of managing their portfolios themselves, and maybe they should. But there is also a large group of DIY investors that are managing their finances like I manage my home maintenance – just doing the best they can when they get around to it.
So what’s the risk of DIY investing? Missing out on just half a percentage point of return per year can have a dramatic difference over time. The difference between a 6.5% and a 7% return on a $500,000 portfolio over 20 years is a difference of over $173,000. That is more than 1/3 of the starting amount! In this case, the damage could be having to work a couple more years or not having as much to spend in retirement.
There is no question that there is an abundance of resources for DIY investors. DIY websites offer tons of research and tips. ETFs are low-cost and broadly diversified. Whether it is an old 401(k) hanging out there, a handful of stocks you’ve bought over the years, or your kids’ 529 plans, the resources are there.
But how do you drink through the fire hose of earnings data, technical indicators, analyst ratings, and the day-to-day news cycle if it ISN’T your full-time job? What is relevant and what isn’t? I would argue that DIY investors have TOO MANY resources available. There has never been more noise out there that may or may not warrant reaction.
Morningstar makes it easy though, right? They use a simple 5-star system to rank mutual funds and ETFs. Believe it or not, even a simple system like that can be misunderstood. First of all, mutual fund managers are not great at beating their benchmarks. According to Standard & Poor, 78% of large cap mutual funds have underperformed the S&P 500 Index in the last three years. 1
You may assume it is the 4- and 5-star funds that are outperforming. Staggeringly, the fewer stars Morningstar rates a stock fund, the less their relative underperformance. In other words, 5-star funds underperform the most and 1-star funds underperform the least on a relative basis.2 Investors continue to prefer 4- and 5-star funds despite their consistent underperformance, because investing just isn’t their full-time job.
What about technical analysis? DIY websites love boasting their technical indicators. By definition, technical analysis uses the patterns of previous price trends to predict future performance. I wouldn’t pin my retirement hopes to a website indicating that they see a “double bottom” in a stock price. I know it isn’t flashy, but asset allocation has proven to be more effective way to generate risk-adjusted returns over a long period of time.
Within most investment strategies, the timing of rebalancing or shifting of modeling assumptions can make or break your performance in a given year. If you do have time to manage your portfolio on your own, does that time fall when it is most advantageous? In other words, do you have time to change the light bulb when it is sunny during the day when help is available, or are you doing it when you get around to it regardless of the conditions? You might be good for a while but it only takes one bad step to fall off the roof.
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1Source: SPIVA Report, June, 2018 https://us.spindices.com/spiva/#/reports/regions
2Source: Morningstar, Inc., Thomson Reuters Datastream. Median performance of stock funds versus style benchmarks over the 36 months following a Morningstar rating.