Self-Directed Investing – Is It For You?
Interested in taking control of your portfolio and becoming a “self-directed” investor within the stock market? Here’s what you need to know.
For most people the idea of self-directed investing comes with a myriad of misconceptions and fears but with the right information and knowledge, making your own decisions can produce significant results. It is not unusual, for example, for self-directed investors to outperform managed money and certainly with a good strategy you can produce well above average returns on a consistent basis.
In a nutshell, self-directed investing means taking the responsibility and control of the decisions surrounding your investments. By opening a self-directed online trading account, you retain the authority to choose the type of investments you want in your portfolio (e.g. mutual funds, ETFs, individual shares, etc), as opposed to ‘managed accounts’ where these decisions are made by a broker or other financial professional. Managed accounts typically have a fee associated with them. (The industry average in Canada is about 2½% of your portfolio per year.)
Why self-direct your investment portfolio?
So is self-directed investing for you? Knowing why you want to do something usually means you have spent some time looking at the pros and cons. For self-directed investing consider the following.
- Pros: More control and the potential for better returns, reduced fees, increased liquidity and greater capital appreciation.
- Cons: Investors assume the risk – and the emotional stress. Many also lack the time, knowledge, and discipline.
If you list out your pros and cons then you can work towards getting the answers you need to make an informed decision.
How much money is needed to invest?
Many people believe that to self-direct an account, you need ‘lots of money’ – but this is not true. You can self-direct any amount. For example, the new Tax Free Savings Account (TFSA) that allows Canadians over 18 to deposit $5,000 each year beginning in 2009, is eligible to be self-directed.
Other accounts that most Canadians have, including RSPs, RESPs, LIRAs (Locked in Retirement Accounts), can all be self-directed. The amount of money is not the issue. Obviously the bigger your portfolio, the better position you’ll be in to buy more shares or more expensive stocks but what’s important to remember is not the amount of money that is working but how it is working.
People with a large portfolio (e.g. $250,000 and above) often start by self-directing only a portion of it. There is nothing wrong with using the TFSA as a starting point. And as you become more knowledgeable over time, you can transfer a portion of your RSP account to a self-directed account without forgoing the tax deferral status.
Do your research first
Before you open your trading account and start putting your money to work, it’s important to take stock (no pun intended) of a few things. First, understand what you are getting into. Most Canadians express a sense of fear when it comes to making their own investment decisions and investing directly in the shares of companies doesn’t reduce that fear. The root cause of this fear, either consciously or subconsciously, often stems from a lack of knowledge on how the markets work and how successful they can be. People often think of investing in the stock market as gambling yet nothing could be further from the truth. If you were to ask those that have built great wealth utilizing the markets, you would rarely find “gambling” as a description of their activities.
Although you don’t need a PhD in Finance or Economics to make good investment decisions, it is essential to educate yourself. It would be foolish to consider that you could fly a plane, run a business, build a house or drive a car without knowledge and training so it should not be a surprise to the investor to spend some time developing a skill-set of making good investment decisions. Skills are learned, practiced, improved upon and finally excelled at. Good habits take more than a weekend to be developed so don’t rush into the markets before you are confident you know what you are doing.
For starters learn the terminology. A great resource is www.getsmarteraboutmoney.ca Developed by the Ontario Securities Commission, this website is a wealth of information on making your own decisions. Then consider your options for education. If you are a novice investor with little to no experience a good foundation is important. Look for a company that provides a well-rounded learning experience and compliment that with your own reading and research. Think about how you have learned other skill-sets in your life and consider adopting that same process.
Develop an investment strategy
Part of your education should include the development of goals and a strategy including a trading plan that matches your risk profile. Setting goals means you can quantify your success at any given time against where you want to be. A good strategy will help you achieve your goals no matter what the market conditions are. And understanding your risk profile will protect you from making decisions that go against your tolerance level. Most novice investors get excited about making money because of course that is the point; however that by itself is not a good plan. A good education will teach you three important principles:
- Capital Preservation – keeping your money so you can invest it tomorrow and beyond.
- Money Management – knowing how to segregate your portfolio and your individual decisions.
- Risk Management – learning how to protect your capital if you make a mistake.
All of these need to be a part of your strategy and decision process.
How much time is needed to self-direct?
Educating yourself takes time – but how much time is needed to manage your portfolio on an ongoing basis? This is a subjective question, and will depend in part on how quickly you want to achieve your goals.
For instance, the investor that makes a few decisions a year and follows a buy and hold strategy will not spend nearly the amount of time that a more frequent trader will. At the same time the investor that makes decisions a few times a month with a good strategy will in all probability create higher returns.
Keep in mind the number of decisions does not necessarily mean an increase in profits. It isn’t how often you put your money to work that counts but how well you put your money to work. A good investor can make 2 to 3 per cent a month on his/her portfolio and for that you should plan to spend about an hour a day keeping informed of what is going on. Don’t shy away from spending the time however, since your financial future is one of the most important aspects of your life.
The bottom line on self-directed investing
Self-directed investing doesn’t have to be time consuming and it doesn’t require a million dollars but it does require knowledge — good goals, a good plan and a good strategy
Self-directed investing – Is it For you?
This entry was posted on Thursday, July 22nd, 2010 at 6:13 pm and is filed under Self Directed Investing . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
