Five reasons to manage your own investments

Most investors use a full-service broker to invest. Here are the reasons why we believe (see Do-it-yourself investing: pro’s and con’s and Categories of investors on our website) you should consider investing on your own:

• The portfolio is entirely focused on your own interests.
• For the expected cost savings
• Pride of self-reliance.
• Because you enjoy the intellectual challenge
• Because you hope for a better net (after costs) return

In comparison, the securities commissions doc.557 give 11 apparently neutral factors to consider to help choose between a discount broker (DIY approach) and a full-service broker (conventional approach). In fact, if you relied on those factors, almost no one would become a self-investor. It would appear that none of the members of the securities commissions are DIY-investors!

Three challenges to the long-term index investing

From the perspective of financial smarts, the bar to long-term index investing is quite low, but two other challenges investors face are to keep themselves free from the gaming instincts experienced by many players, and to ignore the ever-present media hype or noise.

We have previously referred to Siegel  on how easy it is for a novice investor to be as good as the average investor from day one. But you're probably wondering if the smartest people do not invariably perform better than people of average intellectual ability. The happy answer (for most of us) is no. An investment club comprised of Mensa members (people who are in the top 2% of the population for their intelligence quotient) has earned meager results; see Do you have the knowledge? on our website.

Given the poor performance of investors who actively manage its investments, you may wonder, why do they do it? The indexing paradox explains that the search of the thrill of the game can overpower a person’s rational instincts.

Just as an athlete may identify his/her worth based on his/her performance in his/her sport, so might an active investor’s identity being tied to his/her performance in the stock market. For such investors, index investing would be too boring, it would not be a game. To them, actively investing in the stock market is a game.

And this is fueled by all the noise and hype that encourages us to believe in the possibility of beating the market. Market cycles in the stock market are not the same as in the media: 30 to 40 years versus 30 to 40 hours. Follow Henry Blodget’s rule: with regard to your own investments, ignore 97% of what you hear, see and read in the media.; see Blodget .

Three reasons not to invest alone

If you manage your investments yourself, a question that inevitably arises is the following. Is it beneficial to involve others in the process?

There are two reasons to involve your partner, especially if you are a male and your partner is female. First, it will give you a topic of conversation around the dining table (sorry, we consider reading the newspaper not to be a conversation). Secondly, according to a 1999 study by American academics Barber and Odean, it may be profitable to do so. Why?

Investors tend to be overconfident, and this can adversely affect their performance as an investor: Rational investors trade only if the expected gains exceed transactions costs. Overconfident investors overestimate the precision of their information and thereby the expected gains of trading. They may even trade when the true expected net gains are negative. Barber doc.1594, p.26

But this tendency (to be overly confident) occurs more with men. Men and women have complementary investment approaches, but it turns out that the female approach to investing (not suffering from an excess of confidence, they trade less) is more profitable in the long term, and this by about 1% per year.

Psychologists find that in areas such as finance men are more overconfident than women. This difference in overconfidence yields two predictions: men will trade more than women and the performance of men will be hurt more by excessive trading than the performance of women. To test these hypotheses, we partition a data set of position and trading records for over 35,000 households at a large discount brokerage firm into accounts opened by men and accounts opened by women. Consistent with the predictions of the overconfidence models, we find that the average turnover rate of common stocks for men is nearly one and a half times that for women. While both men and women reduce their net returns through trading, men do so by 0.94 percentage points more a year than do women. Source: Barber doc.1594, p. 1.

If you have no spouse, or if you don’t want to fess up to your occasional mistakes (for example, that you trade too often), all is not lost, join an investment club. This will give you an opportunity to relax and have fun. Regrettably, participating in an investment club is unlikely to add another 1% to your returns; see Investment clubs: should you play the game? 

Conclusion

In our next commentary, we discuss rules of thumb explaining why you should invest by limiting both your trading and borrowing.