I have an article in the latest issue of “The Widget”, a magazine put out by the Delta ALPA Master Executive Council. Below is a copy of that article.

The DIY Investor

Many of us are confident that, with the right tools, a well thought-out plan, and a little knowledge, we can fix up our homes as well as a professional contractor—for a lot less money. When it comes to the DIY investor much of the same is true. In order to be successful, you need to develop a sound financial plan and have the temperament to stick with the plan. This can lead to outcomes just as good, or even better, than a professional wealth manager’s.

Developing a Financial Plan and Investment Strategy

Legendary investor T. Boone Pickens once said, “A fool with a plan can outsmart a genius with no plan.” In order to become a successful DIY investor, you must develop and execute an investment strategy that compliments a comprehensive financial plan. A financial plan is a detailed breakdown of income, expenses and wealth through one’s lifetime. A good financial plan will include realistic retirement and planning scenarios, effective tax/estate strategies and a sound investment strategy.

Developing a comprehensive financial plan is no easy feat; it requires motivation and education. The best place to start is the numerous print and online resources related to personal wealth management. The financial-plan area where the most resources (and controversy) exist is investment strategy. (Just 15 minutes of watching CNBC will show you how many different investing opinions exist!). Despite the numerous ways to invest, there are key themes the DIY investor should explore that are part of any strategy:

• Risk/Reward: Risk and reward go hand-in-hand. The higher the potential reward/returns the higher the potential risk; the lower the potential reward/returns the lower the potential risk. The DIY investor’s portfolio must have a risk/reward profile that fits into, and changes with, his overall financial plan.
• Diversification: Diversification is a means of spreading risk (and returns) across various securities. Portfolios are commonly diversified between the most basic asset classes: stocks and bonds. However, there are other areas of diversification the DIY investor should explore: geography, alternative asset classes (e.g. real estate, commodities) and style premiums (e.g. small cap vs. large cap). Regular rebalancing of a portfolio ensures an investor maintains consistent, targeted levels of diversification and risk.
• Active vs. Passive: Portfolios are either actively managed (the investor attempts to beat a market index/benchmark by buying/selling individual securities and/or implementing time-the-market or technical investment strategies) or passively managed (the investor attempts to mirror a market index/benchmark). Mutual funds and exchange-traded funds (ETFs) are also either actively or passively managed. When choosing an actively managed fund, it is crucial to research the track record of the fund manager as well as the fund’s management fees.

In addition to having a sound strategy, a DIY investor must have the discipline to follow through with his/her plan. Warren Buffett has noted, “The most important quality for an investor is temperament, not intellect.” Unless a portfolio is entirely made up of U.S. Treasury Bills, it will go through some periods of stress. Over the last 40 years there have been 15 major financial crises. Most of these crises were resolved fairly quickly, but all presented a temptation for the DIY investor to deviate from his/her strategy. It is important for a DIY investor to realize that risk is embedded into the strategy itself. Markets inevitably fluctuate; a common DIY mistake is to quickly abandon a sound investment strategy by selling securities at market lows and buying back at market highs.

Alternative to DIY Investing

Of course, being a DIY investor is not for everyone. It takes financial education, motivation and discipline. The alternative is to hire a wealth management firm. Here are key considerations when selecting a firm.

• Fiduciary vs. Suitability Standard: Registered wealth management advisors are required to follow one of two standards when dealing with clients. The higher standard of care, the fiduciary standard, requires an advisor to put the client’s best interests ahead of his/her own at all times. The suitability standard requires an advisor to have a reasonable basis for believing a recommendation is suitable for the client. Require that the wealth management advisor put in writing whether he follows the fiduciary or suitability standard
• Conflicts of Interest: Explore any potential conflicts of interest. One way to reduce any conflicts is by selecting a “Fee-Only” advisor, one that is able to collect fees from the client only and not able to collect additional fees from selling certain financial products to the client.
• Full Disclosure: Insist that any potential wealth management advisor provide his/her track record and credentials, detailed management fee schedule, references and, of course, any potential conflicts of interest.

Conclusion

There are many individuals who have the motivation and time to create a successful investment plan and integrate it into their personal finance, risk management, tax and estate plans. These individuals will also have the temperament to keep their heads in tumultuous markets—being fearful when others are greedy and greedy when others are fearful. Great alternatives exist to doing it yourself, but these still require time and thorough due diligence. No matter what you’re considering doing with your wealth, remember the words of T. Boone Pickens and don’t be the “genius” without a plan.