4 Steps to Become a Great DIY Investor

With the increase in competition of low-cost investment brokerage firms, it has never been easier to become a DIY investor. There’s also never been so much noise, and hot takes about how you should invest your money.

In this article, I offer four steps anyone who wants to become a DIY investor should take.

1. Start from a position of financial strength.
2. Consider the alternatives to DIY investing.
3. Make evidence-based decisions.
4. Learn to handle the emotional roller coaster.

Step 1 — Start from a position of financial strength

There is one surefire way to lose money as a DIY investor; selling after a market crash. That sounds obvious. Of course, you shouldn’t sell your investments after a market crash that turns your?paper losses?into?real losses.

We all know we shouldn’t, but many people do sell at the worst possible time. Primarily this is for one of two reasons:

1. They are scared (more on this in step 4.)
2. Poor financial planning.

The stock market tends to crash during economic recessions, which is also when people are most likely to lose their jobs.

There is a risk that investors could lose their job at the same time as their investments are taking a beating.

Even if you are the most rational investor in the world and you know you shouldn’t sell when markets are down, you might not have a choice if you lost your job and you don’t have an adequate emergency fund in place.

This problem can be avoided with some?basic financial planning before you start investing.

• Assessing your level of job security. Ask yourself how correlated your job security is with financial markets? If there was a recession, how likely would you be to lose your job?
• Setting up multiple streams of income. I’ve always chosen to diversify my income by having a side hustle. If I were to lose my job, I would have income to fall back on, which means I’m less likely to be forced to liquidate my investments during tough times.
• Having a strong emergency fund in place. Having a few months of living expenses held in cash can provide financial stability in the event of a job loss.

Step 2 — Consider the alternatives to DIY investing

There are two other alternatives to managing your own investments that you might want to consider.

1. Hiring an investment advisor

Don’t underestimate the benefit of having a professional to talk through investment decisions with, especially when the market is going in the tank, or you are transitioning to a new phase of your financial life.

The issue with hiring an investment advisor is that it can be expensive. Advisors typically get paid in one of two ways:

1. Assets Under Management (AUM). This is where the advisor takes a percentage of your investments they manage as their fee. For example, they might charge 1%, and if you had $100,000 invested, they would charge you $1,000 for the year.
2. Fee-only advice. This is where the advisor charges an hourly rate or a flat rate for advice. Remember, these are highly skilled professionals, so be prepared to pay at least $200+ per hour for the best advice.

2. Using a robo-advisor.

If hiring a human advisor sounds too expensive, you may way to consider using what’s called a “robo-advisor.” Robo-advisors are digital platforms that provide algorithmically based investment decisions and require little human oversight and decision-making.

While you don’t get the same level of service from a human advisor, robo-advisors can get you set up with a portfolio for a fraction of the cost. For example, Vanguard’s?Digital Advisor?service charges 0.15% of the assets it manages for you.

At that price, you would pay about $150 per year for a $100,000 portfolio. A robo-advisor is an effective and affordable alternative to becoming a true DIY investor.

If you’re still determined to manage your own investments, continue reading as we are about to dive into the most important things you’ll need to do.

Step 3 — Make evidence-based investing decisions

Rule #1 to becoming a great investor; Don’t try and be a great investor.

I realize that sounds counterintuitive, so let me explain what I mean. I have read more research papers on investing than I can count, and the most powerful finding is this:

The best investing strategy for the vast majority of investors is to take the average return of the stock market while minimizing your investment fees.

That means:

• Don’t pick individual stocks.
• Don’t bet on individual sectors.
• Don’t chase trends like “mem-stocks.
• Never “trade” stocks, buy and hold.

The most effective investment strategy for most people is to buy into a risk-appropriate portfolio of low-cost index funds and sit on them until you need the money.

If you can do that, you’ll outperform most investors, even some of the “best” investors on Wall Street. The best part is that in addition to providing exceptional expected returns, it is the simplest investment strategy you’ll ever find.

(For a detailed breakdown of how to get started investing in index funds,?check out this story.?)

The truth about investing is that it can be incredibly simple.

But simple does not mean “easy.” In fact, investing is very hard, especially when facing volatility in the market or your personal life. Let’s turn the conversation to sticking with your plan through tough times.

Step 4 — Learn to handle the emotional roller coaster

DIY investors sabotage their own investment returns by making too many adjustments to their portfolios.

Morningstar?looked at the average return of investment funds over the past 10 years and compared that to the actual return that investors in those funds received.?They found that the average investor trailed the return of the funds they were invested in by nearly 1% per year during that time.

• The average fund in the study returned 7.05% per year
• Meanwhile, the average investor returned 6.1% per year
• That is a 0.95% (95 basis points) annual difference

95 basis points is a meaningful difference. Let’s say you invested $100,000 when you were 25 and never invested another dime and pulled the money out at age 65.

• The portfolio returning 7.05% per year would end with $1.525 million
• The portfolio returning 6.1% per year would end with 1.07 million
• That is a difference of $457,000

The DIY investor in this example would cost themselves nearly half a million worth of wealth over their lifetime. The larger the lifetime investment, the more wealth they would be giving up.

Manage your emotions

The primary reason DIY investors tinker with their portfolios is that they are afraid of what they believe to be an impending market crash. They think the market is about to crash, so they sell off some of their riskier investments. The problem is that they are usually wrong, which is why DIY investors have such poor investment returns compared to the funds they invest in.

Step 1 to managing investment fear is to be extremely selective over the financial media you follow.

Find a handful of reliable sources of financial information and tune out the rest of the noise.

Remember, the person with the most followers is not always the most reliable source of information.?Oftentimes, it’s the opposite.?Clickbait like “THE STOCK MARKET IS ABOUT TO CRASH, HERE’S WHAT TO DO” drives more clicks than “Economist looks at data, and provides reasonable forecast of expected investment returns.”

Manage your risk

Once you’ve developed a healthy media diet, the next step to managing your emotions as an investor is to make sure you aren’t taking on too much risk in your portfolio.

If you are so afraid when markets drop that you are tempted to sell your investments, that is a clear sign that you have too much risk in your portfolio.

The simple solution is to reduce the level of risk in your portfolio to something that you can handle during the most volatile times.

Vanguard has developed a?free tool?that helps you determine how much risk you should have in your portfolio. This enables you to determine the right allocation between risky assets like stocks and less risky assets like bonds.

Yes, by reducing the level of risk, you will be giving up higher expected future returns. But remember, the higher expected returns in risky assets like stocks mean absolutely nothing if you are so scared by the inevitable volatility in the stock market that you sell at the worst possible time.

Managing my own investments has been one of the more empowering choices I’ve made in my life. As someone who still has lingering financial anxiety from money issues in my 20s, it gives me a great sense of pride to be making decisions today to improve my family's financial position for years to come.

If you found this discussion useful,?consider picking up a copy of my book “The Financial Freedom Equation” right here.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions

This article originally published on Making of a Millionaire