The Dangers of DIY

23 June 2017  |  Adam French
The Dangers of DIY
Buying funds has never been cheaper, but does this cost saving count when DIY investors underperform the market by 1.5-3 percent a year?
We advocate the use of digital wealth managers instead and discuss the various downsides of ‘do it yourself’ investing.

Last month, Vanguard enabled UK investors to buy their funds from them directly. Previously, investors could only buy Vanguard funds via a fund platform, such as Hargreaves Lansdown. This move sent shockwaves across the industry and shares in Hargreaves fell 8.5 percent on the news. We question whether investors should really be choosing their own funds in the first place and suggest a tried and tested alternative.

What is DIY investing?

DIY investing means that the saver makes their own investment decisions. They assess their tolerance to risk and capacity for loss, review the funds available across the marketplace and choose which one/s they believe will most likely meet their needs. The investor may then keep an eye on markets and manage their portfolios on an ongoing basis, or just stay invested in their fund/s of choice. There is plenty of information out there, it’s just up to DIY investors to find it.

We can’t help but feel instinctively wary of this investment strategy. DIY investors take responsibility for the profitability of their own savings and that strikes us as a risky strategy. Here are some factors to consider when deciding if DIY investing is for you.

D-I-Why?

If you like to know that there is always someone at the end of the phone, DIY investing may not be for you. Buying a combination of funds from a platform will not be accompanied by a team of support staff and services.

This will become immediately apparent when you have to conduct your own risk assessment; no easy task. How do you begin to make an assessment of your own tolerance to risk? I can almost imagine the thought process: I’ve skydived, does that mean that I should go into a higher-risk fund? That is a simplistic overview, but the point is valid: risk appetite is intangible. An accurate assessment of your own risk tolerance in relation to investing is very hard to calculate. Get your risk profile wrong, end up with more or less risk in your portfolio than originally perceived and performance will not run as you intended. To generate decent risk-adjusted returns, risk should remain closely controlled at all times.

Those clients of digital wealth managers will have their tolerance to risk assessed and their portfolio managed in line with their results. The DIY investor will have to manage their own portfolio according to their own assessment of their risk tolerance. This means calculating the risk in their portfolio and continually comparing it against their assessment of their own risk tolerance. These calculations alone are challenging, but trying to make investment decisions by comparing one with the other seems almost impossible. The ongoing management of a portfolio in line with risk tolerance strikes me as a task best outsourced.

The Sound of Silence

A lot of savers are reassured by a calming email explaining why markets have fallen and that they can eventually expect to see their portfolio return to positive performance. DIY investors may find the sound of silence a little deafening in those instances. Communication isn’t the only reason that investors opt out of DIY, but knowing there is someone to call in times of crisis is certainly a comfort for many.

The DIY investor will also miss out on helpful guidance about how best to use ISA and pension allowances. Tax rules never stand still and changes are made almost every year. The DIY investor may struggle to keep fully up-to-speed with the changes and how best to take advantage of them; use of their tax-free allowances may suffer.

Serious Excel Skills Required

Asset allocation style is fundamental to investment management. Asset class weightings can either be fixed or dynamic; at Scalable Capital we favour dynamic. Dynamic asset allocation generates smoother long-term risk-adjusted performance but it is a complex strategy for a private investor to implement himself. Few Excel spreadsheets will be able to conquer calculations of that sort. It’s likely that the DIY investor will opt for fixed asset allocation but their returns will suffer accordingly.

We suggest you take advantage of the sophisticated technical services available through a digital wealth manager, your returns will benefit. To read more about our dynamic asset allocation please see our article: Are Multi-Asset Funds an Alternative to Digital Wealth Managers?

Cash Rich, Time Poor

Managing your own investments is also time-consuming. We all lead busy lives and finding extra time to research funds isn’t easy.

It seems more convenient to pay a digital wealth manager one fixed fee which then takes care of everything. You can check in on performance whenever you want or you can completely forget about your portfolio, safe in the knowledge that your investments are being managed in line with your risk tolerance. The ease of having a professional taking care of your investments is worth the fixed fee.

These results suggest that the alpha that the average hedge fund investor thought they were accessing may have been almost completely offset by poor investment timing decisions.

Cass Study

Underperformance

A non-professional investor making their own financial decisions is not guaranteed stunning outperformance. Navigating the capital markets is not an easy task and their complexity should not be underestimated. A DIY investor has to consider their own financial objectives, their tolerance of and capacity for risk and then construct the right portfolio for them. If a saver happens to get this balance of assets perfectly right, they are then faced with the ongoing challenge of managing the portfolio without any bespoke advice.

This is when behavioural finance becomes challenging. It is only natural to sell when the value of your portfolio is plummeting, for fear of greater loss. An investor may then sit in cash until the markets start rising again and buy their stocks back – inadvertently they have sold low, bought high and sat in cash in the interim. Research illustrates this weakness and shows that private investors managing their own portfolios typically underperform the market by 1.5-3 percent every year.* The path to strong investment returns is not guaranteed to run smoothly if an investor decides to DIY invest.

Another Way

Fortunately, investors don’t have to do it themselves. Choosing to invest with a digital wealth manager will save the investor a lot of time as well as increasing their chances of outperformance.

Online wealth managers will make an accurate assessment of risk tolerance and manage your portfolio accordingly. Risk will be monitored and performance updates given in real time. Transparency is paramount to the success of the wealth manager; if a client has any question about their portfolio, they will quickly find it answered.

Our proposition at Scalable Capital fulfils all of these criteria and more. Our risk management technology allows us to give clients an accurate probability of downside loss. Risk stays under control at all times.

Source: https://www.cass.city.ac.uk/__data/assets/pdf_file/0003/69933/Do-UK-retail-investors-buy-at-the-top-and-sell-at-the-bottom.pdf
Image: Unsplash.com

Risk Warning – With investment comes risk. The value of your investment can go down as well as up and you may get back less than you invest. Past performance or future projections are not indicative of future performance. We do not provide any investment, legal and/or tax advice. If this website contains information regarding capital markets, financial instruments and/or other topics relevant for investments of assets, the exclusive purpose of this information is to give general guidance on investment management services provided by members of our group. Please note our Risk Warning and the Website Terms.

 

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Adam French
CO-FOUNDER & DIRECTOR
Adam spent the last 8 years working in London in the financial services industry. As Executive Director of Commodities Trading at Goldman Sachs, he was responsible for the Commodities Structured Products franchise. Prior to this, he worked in Derivatives Trading where he was responsible for electronic trading for private clients in fixed income, currencies and commodities products. Adam studied Business Mathematics and Statistics at the London School of Economics.