The seven pitfalls of DIY investing

With the introduction at the start of the year of news rules creating transparency around the true cost of financial advice and the withdrawal from the advice market by some high street banks, it is believed the numbers of "DIY investors" - those selecting and managing their investments without an adviser - are growing rapidly. However those considering whether to self-manage their investments or in the process of choosing a DIY platform need to be aware of the potential pitfalls. We have identified seven key perils that confront DIY investors:

Published on 22 Aug 20135 minute read

Written by Tim Stalkartt

1.Self-Mis-selling
Inexperienced investors run a real risk of "self-mis-selling" i.e. buying investment products that are not suitable for their goals, time horizon and circumstances. It is easy to get swayed by articles on whatever is currently topical and funds being heavily tipped, but these may not be suitable for your circumstances. Successful investing should be anchored around a well thought out strategy where decisions are made in the context of how they fit with the overall portfolio. Buying investments on an ad hoc basis can lead to unnecessary levels of risk. It is important to understand that investing without advice carries less regulatory protection than taking advice.

2.Driving while staring in the rear view mirror
Novice investors might assume that DIY-investing is as straightforward as choosing the funds that top a performance league table or have the lowest costs. Unfortunately, the past is no guarantee of the future. To select a fund on backward-looking data alone is akin to driving a car at high speed while only staring in the rear view mirror and not looking ahead. If you are a DIY investor, don't underestimate the importance of access to quality research to help you make decisions. Unbiased research, rather than relentless marketing, should be an important consideration when selecting an execution-only broker or DIY platform.

3.Ignoring investment trusts
Some fund supermarkets and execution-only brokers only provide access to limited fund ranges or their research only covers commission paying funds, not investment trusts. Investment trusts are often superior to open-ended funds, so don't ignore them. However, it is important to understand whether a trust is trading at a discount or premium to its net asset value before making a purchase.

4.Forgetting asset allocation
The key to successfully managing an investment portfolio is deciding on an appropriate asset allocation strategy to suit your objectives and risk profile; in layman’s terms, the mix between equities, bonds, property, alternatives and cash, as well as how your investments are spread between different countries, industries and between large, small and medium sized companies. Numerous academic studies have shown that asset allocation is a bigger driver of differences in returns between portfolios, than the individual funds or shares selected, yet most execution-only brokers provide little information on asset allocation and many instead push investors towards specific products. Without an asset allocation strategy, DIY investors can end up sleepwalking into a portfolio with poor risk/return characteristics.

5.Failing to understand risk
In the investment world, the more risk you take, the greater the potential gains - although this isn't guaranteed or it wouldn't be risky. The longer your time horizon the more risk you can potentially take, because you have more time to ride out any short-term volatility. Yet there are many ways to quantify risk, and most DIY platforms provide little help in this respect. One useful measure is to understand the volatility of a portfolio, which is the extent to which it could fluctuate in value. While this has limitations because it is based on the past, it is a good starting point.

6.Not rebalancing
Even when a DIY investor carefully plans an asset allocation strategy to suit their risk appetite and goals, it is vital for them to monitor how this changes over time and to periodically rebalance their portfolio. This is because the performance of funds and asset classes will vary, meaning that the original asset allocation will drift, potentially resulting in the portfolio changing risk profile and no longer meeting the investors’ original objectives. In selecting a broker or platform, DIY investors should check whether asset allocation analysis is provided so they can monitor their positions. It makes sense to rebalance at least once a year.

7.Lack of monitoring: who's managing your money?
If you are going to invest in actively managed funds, it is vital to look behind the record of the product to understand the personal career track record of the manager responsible for it today. Once invested, you need to be aware of any potential changes that could impact future performance, such as a change in key personnel or excessive growth in fund size. DIY investing isn't just about doing your homework prior to making an investment. On-going monitoring is essential and the extent to which your broker provides you with help in the form of research and alerts is another key consideration when choosing a DIY platform.

We have been supporting DIY investors for more than two decades and see this part of the market growing rapidly. However, DIY isn't going to be suitable for everyone and investors should think carefully before giving up on advice. In our experience, the vast majority of people are still looking for a helping hand in the form of research ideas and the tools to help them better plan and monitor their portfolios. In this respect the various DIY platforms available are not all the same, so it is important to look at the services and tools on offer when choosing an execution-only broker as well as the costs.