So you want to get rich, right? You have worked hard for years and saved a bit of money aside and now you want that money to work for you.
This article is to dissuade you from DIY investing despite the many advantages it offers.
You have looked at all the options and decided that you wish to invest in the stock market as it delivers the best returns over the long-term.
But how do you invest in the stock market? Generally speaking there are three main options:
- Tracker funds – this means your money will move in line with some stock market index such as the FTSE and cost around 0.1% a year.
- Actively managed funds – this means that pay someone to make decisions about what to invest in on your behalf. This option costs around 1-2% a year.
- DIY investing – this means that you make the decisions about what to invest in yourself. Generally there is a fixed price or around £13 for buying or selling a share.
This article focusses on the third option.
Do-it-yourself (DIY) investing sounds appealing. You can put money in an account, select some shares, watch them skyrocket and then retire at 40.
Even better if you put the money in an ISA (tax-free savings account) or a SIPP (personal pension) all capital gains and dividends are completely tax-free.
There are even entire magazines, such as Investors Chronicle, devoted to individual stock picking.
DIY Investing Versus Other Share Buying Options
The main problem with tracker funds is that they are effectively momentum investments.
Let’s say you invest in the FTSE 100. If one of the stocks in this index performs well it becomes a larger part of the index and the tracker fund then has to purchase more shares in this stock.
This means that you are always buying more of the stocks that have recently been winners. This is fine if the winners remain winners.
The main problem with actively managed funds is that they are quite expensive in the current environment.
A typical fund may charge at least 1% a year to make decisions on your behalf. In a period of low interest rates you would be lucky to earn 5% a year. This means that you are paying 20% of your return to the managers.
There is also a huge amount of academic evidence that active management does not work even before you take into account the extra expenses. For example “This Is Money” found that 73% of UK fund managers underperformed their benchmark. A benchmark is usually an index such as the FTSE 100.
Advantages of DIY Investing
So I have sold you on the benefits of DIY investing? Like any good salesman let’s see if I can push this even further.
Aside from the above advantages relative to the other share buying options there are other benefits to choosing your own investments.
The first is that you choose what to do and when. Active managers are generally part of a large institution and this means there is pressure on what is bought and sold and when. For example if a stock is underperforming relative to a benchmark, and the firm is at risk of losing clients because of the performance, there will be pressure to sell the stock even if the managers still believes in the investment.
The second is the intellectual challenge of DIY investing. Learning about stock markets and how companies work is fascinating, challenging and rewarding.
I know my readers are highly intelligent and would appreciate the challenge. Or maybe it is fascinating if you are a dull actuary like myself.
The third is that DIY investing is an emotional challenge. When you have done your research it is an emotional rollercoaster watching your money go up and down with market movement and the individual fortunes of the companies you have chosen.
Disadvantages of DIY Investing
The big disadvantage is that you could lose a large amount of money.
The other disadvantage is that you might find investing very stressful and you probably have enough stress in your life.
Is DIY Investing The Right Option?
No, but the reason is quite subtle.
Until recently I had been a DIY investor as a previous hobby i.e. the one before writing this blog. I invested in individual shares for the past 5 years. I was also a very successful DIY investor. My returns were around 1-2% a year above my benchmark, the FTSE All Share. This is way above the vast majority of active fund managers.
If I worked for a large investment institution I would be on the front cover of business magazines. I would be looking out smugly in the middle distance with a caption that reads something like “where will the Oracle of Middlesbrough (my home town) invest next?”
This suggests the advantages outweighs the disadvantages. If a hobbyist can outperform the active managers then surely anyone can?
The problem is with the amounts of money invested. Let’s take 1% above the benchmark as an example.
If you have £10,000 invested it is only an extra £100 a year. At £100,000 it is only £1,000 a year and at £1,000,000 it is £10,000 a year. I did not have a million pounds to invest.
If you are thinking of DIY investing consider the advantages and disadvantages but also consider the number of hours spent on research.
If you have invested £100,000 and spent 100 hours researching your investments over the year then the £1,000 a year extra that you have made (relative to tracker funds) works out at around £10 an hour.
Do this calculation and ask yourself whether the effort is worth the reward. You will probably find that you are being badly paid for your services.
David is an actuary working for Phoenix Group in Birmingham and writes a blog on dubious claims in the media (http://dodgystatistics.com). Facebook: Dodgy Statistics.