Managing Your Own Investment Portfolio: Is It Worth It?

Managing your own investment portfolio can be a challenging task. While the internet has made it easier for individuals to access the tools and information needed to manage their finances, it is important to have the knowledge and experience to use these tools effectively.

Building a successful investment portfolio requires a solid understanding of financial principles, such as modern portfolio theory and risk management. It also involves determining one's financial goals, risk tolerance, and investment strategies.

Additionally, managing an investment portfolio is an ongoing process that requires regular monitoring, reevaluation, and rebalancing to ensure that it remains aligned with one's financial goals and risk tolerance.

While it is possible for individuals to manage their own investment portfolios, it may be beneficial to seek professional advice or utilize resources such as robo-advisors or online communities of investors to make more informed decisions.

Understanding your risk tolerance

When assessing your risk tolerance, it is important to consider your investment goals and time horizon. Younger investors with a longer time horizon are generally considered more risk-tolerant and may be more inclined to invest in stocks and stock funds. However, it is important to note that age is not the sole determining factor, as people are living longer and can remain aggressive investors well into their retirement years.

Your net worth and liquid capital also play a significant role in risk tolerance. Investors with a higher net worth and more liquid capital can typically afford to take on more risk, as they have a larger financial cushion to withstand potential losses. Conversely, those with limited financial resources may be more risk-averse to avoid significant financial strain.

Investment experience is another factor that influences risk tolerance. Inexperienced investors may exhibit behaviours such as buying high and selling low, which can lead to short-term losses. Therefore, it is advisable to gain experience and understanding of the market before committing significant capital.

It is worth noting that risk tolerance is dynamic and can change over time. Life events, financial goals, and changes in an investor's financial situation can impact their tolerance for risk. For example, an investor with intermediate financial goals, such as saving for their child's education or starting a new business, may need to adjust their portfolio accordingly.

Additionally, it is important to understand the difference between risk tolerance and risk capacity. While risk tolerance measures an investor's willingness to take risks, risk capacity assesses their financial ability to do so. A comprehensive understanding of these concepts will enable investors to make more informed decisions about their portfolio allocations.

Choosing the right investment options

• Determine your financial situation and goals: Consider your age, investment horizon, capital, and future income needs. For instance, a young college graduate starting their career will have different investment needs than someone nearing retirement.
• Assess your risk tolerance: Are you comfortable with potential short-term losses for higher returns? If you're averse to risk, opt for lower-risk investments like bonds. If you can handle volatility, stocks may be a better fit.
• Diversify your portfolio: Diversification helps reduce risk and enhance returns. Spread your investments across different asset classes, such as stocks, bonds, real estate, and alternative investments.
• Choose the right asset allocation: Allocate your capital between asset classes based on your risk tolerance and goals. For example, if you're comfortable with higher risk, allocate more to stocks; if you prefer lower risk, consider more bonds.
• Understand different types of investments: Investments can be broadly classified as defensive or growth. Defensive investments, like cash and fixed-interest options, are lower-risk and aim to protect capital. Growth investments, such as stocks, property, and alternatives, offer higher potential returns but come with higher risk.
• Conduct thorough research: Before investing, research the investment's performance history, risk factors, fees, time horizon, legal and tax implications, and how it fits into your portfolio.
• Consider seeking professional advice: If you're unsure, consult a financial adviser to help you set goals, assess your risk tolerance, and choose suitable investments.
• Monitor and rebalance your portfolio: Regularly assess the performance of your investments and adjust their weightings as needed. This ensures your portfolio remains aligned with your goals and risk tolerance.
• Keep costs low: Be mindful of brokerage fees and mutual fund expense ratios, as these can eat into your returns over time.
• Commit to a long-term timeline: Investing is typically a long-term endeavour. Give your investments time to grow and compound, weathering the ups and downs of the market.

Managing psychological pitfalls

Managing your own investment portfolio can be a challenging endeavour, and it is important to be aware of the psychological pitfalls that may arise. Here are some key points to consider:

Overconfidence and Illusory Superiority

People tend to overestimate their qualities and abilities, and this phenomenon is known as illusory superiority. When it comes to investing, you may believe that you are a better investor than you actually are, especially if you don't work in the investment industry. It is crucial to be realistic about your skills and knowledge and not let overconfidence lead to poor investment decisions.

Loss Aversion

Loss aversion refers to the psychological impact of losses, which tend to trigger a much stronger reaction than equivalent gains. Losing $1,000 often hurts more than winning $1,000 feels good. This bias can lead to poor investment behaviours, such as investing only in low-risk, low-return investments, or holding on to losing positions for too long. It is important to recognise this bias and not let it dictate your investment strategy.

Anchoring

Anchoring is the tendency to rely too heavily on one piece of information when making decisions. For example, investors often view the success or failure of an investment in relation to the original purchase price. While this may not be a problem initially, it can impact the decision to sell. Investors may base their decision on whether they have a gain or loss, rather than on the future outlook for that investment. It is important to logically evaluate all relevant information and not be anchored to a single data point.

Herding

Herding is the natural tendency to feel safe and secure when following the crowd. In investing, this can lead to chasing rising markets and fleeing during market crashes, which can be detrimental to overall performance. It is important to make investment decisions based on your own research and analysis, rather than simply following what others are doing.

Confirmation Bias

Confirmation bias is the tendency to seek out information that confirms our existing beliefs or expectations. When it comes to investing, this can lead to making conclusions first and then looking for evidence to support them, rather than objectively evaluating all available facts and data. It is important to recognise this bias and actively seek out diverse perspectives and information sources to make more informed investment decisions.

Emotional Discipline

Investing can be an emotional endeavour, and it is crucial to maintain discipline and not let emotions rule your portfolio management decisions. Rash decisions based on emotions can often lead to disappointing returns. Developing a comprehensive investment plan and staying focused on your long-term goals can help mitigate the impact of emotions on your investment strategy.

Knowing when to rebalance

Rebalancing your investment portfolio is a crucial step in maintaining your desired asset allocation and managing risk. It involves buying or selling certain investments to return your portfolio to its intended mix of stocks, bonds, and other assets. Over time, your portfolio's performance and market movements will cause the weightings of different assets to deviate from your initial plan. Knowing when and how to rebalance is an essential skill for any self-managed investor.

There are a few approaches to determining the right time to rebalance:

• Time-based rebalancing: You can choose to rebalance your portfolio at regular intervals, such as annually, semi-annually, or quarterly. This approach helps to simplify the process and ensures that you actively review your portfolio regularly. For example, you might decide to rebalance your portfolio every year on a specific date. This method can help to reduce the emotional factor in decision-making and provides a disciplined framework for managing your investments.
• Percentage-based rebalancing: Another strategy is to rebalance when the allocation of a particular asset deviates from your target by a certain percentage. For instance, if your target allocation for stocks is 60% and you decide on a 5% threshold, you would rebalance whenever the actual stock allocation goes above 65% or falls below 55%. This method allows for more flexibility and responsiveness to market movements.
• Combination approach: You can also combine the above strategies by setting regular review dates and then assessing whether rebalancing is necessary based on the percentage deviations from your target allocations. This provides a structured process while still allowing for dynamic adjustments.

Regardless of the approach you choose, successful rebalancing requires a clear understanding of your investment goals, risk tolerance, and the overall market environment. It is important to remember that rebalancing involves selling assets that have outperformed and buying more of those that have underperformed. This can be emotionally challenging, especially if you need to sell investments that are doing well. However, it is a critical step in managing risk and ensuring your portfolio remains aligned with your long-term goals.

Additionally, consider the costs and tax implications of rebalancing. Each time you buy or sell investments, there may be transaction costs involved, and if you are realizing capital gains, there could be tax consequences. Therefore, it is essential to carefully assess the potential benefits of rebalancing against these costs and incorporate tax-efficient strategies where possible.

When to seek professional advice

Managing your own investment portfolio can be a challenging task, and there are several instances when seeking professional advice may be beneficial. Here are some scenarios where consulting a qualified investment professional can be advantageous:

• Complexity of Investment Decisions: If you feel overwhelmed by the complexity of investment decisions, it is wise to seek advice. Financial planners, investment advisers, and brokers can provide guidance tailored to your financial situation and goals. They will consider factors such as your risk tolerance, time horizon, and investment objectives to develop a comprehensive plan. This can include creating a diversified portfolio, selecting appropriate investment vehicles, and regularly reassessing and rebalancing your investments.
• Limited Time and Expertise: Managing an investment portfolio requires significant time and expertise. If you have a busy schedule or lack the necessary knowledge and experience, consider consulting a professional. They can help you navigate the vast amount of information and make informed decisions. Professionals also have access to proprietary software and research tools that can aid in analysing investments and developing strategies.
• Major Life Events: Life events such as marriage, divorce, the birth of a child, or a change in your financial situation may warrant seeking professional advice. These events often have significant financial implications, and an investment professional can help you navigate them effectively. For example, they can assist with retirement planning, saving for college, or adjusting your investment strategy to accommodate new financial goals.
• Risk Management: Understanding and managing risk is a critical aspect of investing. Investment professionals can help you assess your risk tolerance and make suitable investment choices. They can provide insights into different types of risk, such as market volatility, liquidity risk, and investment concentration. Additionally, they can guide you in avoiding common behavioural biases that may lead to irrational investment decisions, such as loss aversion, anchoring, herding, and overconfidence.
• Regulatory and Legal Considerations: The financial industry is highly regulated, and there are legal implications when providing investment advice. Investment professionals are well-versed in these regulations and can ensure compliance. They can also offer guidance on tax implications, estate planning, and other legal considerations related to your investments. This can help you avoid potential pitfalls and ensure your investment strategies are aligned with relevant laws and regulations.
• Underperformance and Subpar Returns: If you consistently underperform the market or experience subpar returns, it may be time to consult a professional. They can evaluate your current investment strategies, identify areas of improvement, and suggest alternative approaches. Professionals have a deeper understanding of market dynamics and can provide insights into passive investing, index funds, and algorithmic portfolio management strategies that may enhance your returns.

While managing your own investment portfolio is possible, seeking professional advice can provide valuable insights, expertise, and peace of mind. Investment professionals can help you navigate complex decisions, manage risk, and optimise your investment strategies to align with your financial goals. Remember to research and choose a qualified and reputable professional who suits your needs.

Frequently asked questions