Thursday 6 December 2018 9:53 am Netwealth

Is DIY investing a cheap trick?

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As passive investors, we sometimes get asked by clients and prospects: “Why don’t I just invest in passive funds and exchanged-traded funds (ETFs) directly myself?”

And at first glance, DIY investing may seem like the cheapest way to invest. But some professional services can actually work out as a much more cost-effective means of investing, while also delivering better returns in the long run.

Cheap, but costs add up

DIY investing may well be the cheapest option – but it’s not always the most cost-effective way to attain a diversified portfolio to spread risk and protect your investments.

A well-diversified portfolio not only requires knowledge and effort to understand how the moving parts interact, but can also be costly if constructed through a DIY platform.

On the surface, DIY investing may seem like an inexpensive option – individuals can, for example, invest in a single equity index-tracking fund at a very reasonable cost, say for 0.2 per cent.

However, a properly diversified portfolio will necessitate a number of these funds, meaning that you can expect that 0.2 per cent fee to increase incrementally.

Owning funds also requires a platform or a wrapper to host the investments, which will usually be another 0.1 to 0.2 per cent a year at a minimum, in addition to transaction costs hidden in the small print.

So, while DIY investing may look cheap at first glance, when you delve into and add up all the costs that you may incur, it can actually work out just the same, if not better value, to pay an all-in fee to professionals to manage your portfolio.

The expertise and resources of professionals also make them better placed to secure you a strong return in the process.

Behavioural biases

Even the most financially literate investor can fall prey to the many human biases that all people face.

There is a library of academic literature which examines why we can lose objectivity, and often make mental shortcuts that result in poor investment decisions.

For example, you may be familiar with the old adage “losses loom larger than gains”. This means that many of us delay making a decision that could incur a feeling of loss, as we don’t want to conclude that we have made a poor decision.

As a result, investors can be slow to sell a failing investment or reverse an ill-considered action.

Herd behaviour is also extremely common. As humans we find safety in numbers, so it is not unusual to follow the herd – yet the crowd is not always right, nor wise.

From the Dutch tulip bulb mania of the seventeenth century to the spectacular rise and fall of many cryptocurrencies, blindly copying the actions of the many can lead us into financial trouble.

These thinking traps (which can include loss aversion, overconfidence, and familiarity bias) can have considerable effects on investor outcomes.

For example, increased volatility may prompt the kind of behaviour that leads investors to miss out on the best periods for investment returns, which can be concentrated over short periods of time.

For instance, missing only the 10 best trading days in the US S&P 500 index from 31 December 1986 to 25 September 2017 would have resulted in returns of 399 per cent, compared to 933 per cent by remaining invested throughout, according to Bloomberg and Netwealth calculations.

All of these biases, however, can be overcome by a watchful, experienced and objective team with all the necessary experience needed to make informed decisions about where and how to invest.

Watchful thinking

For many DIY investors, researching investment opportunities, watching the markets, and monitoring their portfolios may be fun as a hobby.

But even the most enthused and financially literate DIY investor will rarely have the time or inclination to stay completely on top of their investment portfolios in a disciplined way – there’s a difference between knowing what you’re doing, and wanting to do it in your own time.

For a small fee, not too dissimilar to what a DIY investor would expect to pay each year, you can have your portfolio managed by an experienced, dedicated and cost-conscious team, who are watching the screens so you don’t have to.

Passive, not inactive

A passive approach may be misconstrued by many as being inactive – yet this involves taking a strategic, long-term view when building the right asset mix.

While professionals are always keen to avoid unnecessary trading, as the economic and market environment changes over time, asset allocations may also need to change. This can either be a strategic shift, or on some occasions more of a cyclical change to address short-term risks.

With the development of passive funds, it’s easy to manage your investments yourself.

But with modern wealth managers offering to look after your investments for an all-in fee of under one per cent a year, why would you choose to go it alone?