Tuesday, June 8, 2010

Test Driving DIY Investing

Many people asking me about do-it-yourself (DIY) investing. Despite their initial interest, the usual result is for these investors to take no action and continue investing in expensive mutual funds. This has caused me to rethink how best to approach the subject. I now think that investors might be best to try easing into DIY investing rather than deciding whether to make one big jump.

To illustrate how these interactions between me and a curious investor tend to go, I'll describe the case of a particular investor and acquaintance of mine who I'll call Sam. Sam said he heard that I write a Money blog and wondered if I might advise him on whether he needs to change anything about his investments.

Sam had a financial advisor who he seemed to like on a personal level but didn’t make him feel comfortable about his investments. Sam couldn't understand much of what was on his multi-page account summary other than the dollar amounts that weren't going up as fast as he hoped. Sam owned several mutual funds with impressive-sounding names and impressively high MERs.

I looked up Sam's mutual funds for him to show him how they were split between stocks and bonds, and how much he paid yearly in MER fees to own these funds. Then I showed him how he could replace these mutual funds with index ETFs or index mutual funds that have the same mix of investments but are much cheaper to own.

Sam pondered all this information and asked a few more questions about the mechanics of opening a discount brokerage account and making trades. Then he froze and chose to do nothing. My efforts did little other than leave Sam with vague guilt that he should do something, but he was afraid to do anything. I'd like to think that he decided that his financial advisor was doing a great job and that Sam should stick with him, but that was definitely not the case.

I think what froze Sam was too many new things at once. He was uncertain about whether he had the temperament to handle DIY investing, he didn't know how to open the new accounts he would need, and he didn't know for certain whether low-cost funds really were likely to outperform his active mutual funds over the long run.

Instead of trying to decide whether to make all the changes at once, Sam would likely have been better off easing in slowly. He could have opened a single account with a discount broker and put a modest sum into it while continuing to hold his mutual fund portfolio with his advisor. Then he could have purchased a single ETF with the money and watched it for a few months (or longer).

Having become comfortable with some aspects of DIY investing, Sam would then have been in a much better position to decide whether to expand his DIY side or shut it down. So this will become my new mantra with people who ask me about their investments. I still prefer to explain things rather than tell people what to do, but I will suggest sticking just a toe into DIY investing first rather than trying to decide between doing nothing or plunging in all at once.


  1. It is a funny thing you've noted that I have seen too. It is a hard mental transition for people used to being told exactly what to do or used to having it done for them without thinking about any of the details, to make that step into DIY. Even at its simplest, DIY is more complicated than mutual funds. It is a reason I think mutual funds continue to prosper despite the increasing recognition that they charge a lot - part of the "value" is the convenience factor.

  2. @Financial Cents and @Canadian Investor:

    I think some people who are good candidates for DIY investing and who are willing to learn and do some work are still scared off by the apparent enormity of shifting a large sum of money from an advisor to their own control. For these people, I suggest trying DIY investing on a small scale first while leaving the bulk of their savings alone. Facing too much uncertainty and too many big changes all at once can induce paralysis.

  3. pect that the advisor can easily convince Sam that he (the advisor) knows what he is doing and that Sam, left to his own devices, would fare far less well in the markets.

    What he doesn't stress is the obscene fees charged.

    The other fact not mentioned is that those mutual funds underperform the indexes, partially becasue of those fees.

    Bummer for Sam.

  4. @Mark: Your comment led me to an interesting question: Should you tell your advisor that you're "test-driving" a DIY approach? It's probably easier not to tell the advisor in the sense that it avoids conflict. On the other hand, if you can't withstand the advisor's reasons for why you shouldn't try DIY, maybe you're really not cut out for DIY.

  5. @Thicken: Hiring an expert to spend a couple of hours going over an investor's financial situation and make recommendations is an excellent alternative to working with a mutual fund salesman. Maybe more people would take this path if they understood how much they were paying to own typical mutual funds.

    I've heard a couple of complaints from people who say that they can't find a financial planner who will work by the hour. I've never tried to find one; so I don't know if this really is difficult.

    1. The comment above is a reply to Thicken My Wallet's comment:

      Isn't the other solution simply to hire a financial planner to put together a plan and then to arrange monthly meetings to map out progress and accountability goals? If you miss an accountability goal, you have to do something you absolutely hate.

      I think Canadian Investor hit the nail on the head, we are conditioned to be told what to do. Having freedom is an exciting and scary proposition at the same time.

  6. I offer to manage their money for a year, or so, and show them how to do it themselves. For this the fee is .4% of the market value of assets. The setting up is the work and it of course involves selling existing assets which is not easy - you've got cost basis issues and figuring out the location of ETFs to minimize taxes etc. This is not to mention the need in some cases to do some risk tolerance analysis.
    Once it is set up I then like to sit down with the client at the laptop and execute a couple of buys and let them execute a trade or two if they have never done that.
    Once they take over there are 2 issues as I see it. They need a little guidance on rebalancing and they need a serious talk about emotions and investing. I am available after they take over on an hourly basis and ask that they talk to me before making a big shift.
    You are exactly right - even if you lay out in excruiating detail what to do most people won't carry through.