Like most Do-It-Yourself (DIY, independent) investors who have an account with a discount broker, you probably already figured out that the minimization of costs of all kinds is a key element of a long-term investment plan. If the assets in your account are important enough, you probably pay no more than $ 10 per stock trade, and that's great news.
On the other hand, when you manage your own portfolio, other important elements should also be considered.
90% of your portfolio return comes from the choice and weighting of the different asset classes such as stocks and fixed income.  These major asset classes can be subdivided in several sub-asset classes. Thus, stocks may include Canadian stocks, small cap stocks, international equities, emerging market equities, etc. Fixed income may include government bonds, corporate bonds, high yield bonds, preferred shares, money market instruments, etc. . Did you know that over a third of do-it-yourself investors do not have any fixed income in their portfolio? Generally, a portfolio that includes several asset classes will have a lower volatility and offer a higher risk-adjusted return.
Solution :Using a a few ETFs, you can create a globally diversified portfolio in several asset classes.
To make sure that the asset allocation of your portfolio is always right for you, it is important to rebalance your portfolio regularly. How often? There is no clear answer. You should not wait too long because the portfolio could become too (not enough) risky relative to your risk tolerance and your investment goals. In contrast, a high frequency rebalancing strategy would entail high transaction costs and reduce your long-term performance. Too often, in a bear market, self-directed investors tend to ignore their portfolio and wait until a bull market comes back. Solution: Establish clear rules that you will apply in all market conditions.
Solution: Establish clear rules that you will apply and follow in all market conditions.
Although they are not always apparent, the costs of bond transactions often exceed 1.5% of the value of the transaction. This is the difference between the market value of the obligation and the agreed price for the transaction. If you buy and then resell the bond, the combined costs are then 3.0% for the period you held on to the bond. In an environment of low interest rates, it becomes difficult to justify such high fees unless your holding period is several years.
Solution : Using ETFs is a low-cost way of investing asset classes such as bonds, where the individual transaction costs are too high for do-it-yourself investors.
For mutual funds trades, discount brokers often charge nothing if you hold them long enough. The reason is simple. Discount brokers receive monthly commissions from fund managers out of the management fees that are charged to the fund. The same fees that would be paid to a financial adviser that would have recommended that fund to you. It is important to know that these management fees, which are generally above 2% for equity funds, are directly reducing the returns on your investments.
Solution : Using ETFs instead of mutual funds can significantly reduce these costs.
Did you know that a minimum of 20 stocks is required to properly diversify a stock portfolio? Most do-it-yourself (independent) investors own less than six different stocks. It is therefore not surprising that do-it-yourself portfolios are far riskier and are subject to daily variations that are significantly larger than the general stock market indices.
Solution: Using a few ETFs, you can adequately diversify a portfolio with very few trades, and at low cost.
Stock selection is a task that requires a lot of time. Financial markets are a very competitive field and new information on a company is quickly reflected in the share price. In Canada, there are currently more than 10,000 financial analysts and approximately 4,000 companies listed on the stock exchange (September 2011).
In a recent survey conducted in 2011, it was shown that the majority of do-it yourself (independent) investors overestimate their ability to detect an exceptional stock in a basket of 20 stocks. They have a strong preference for speculative stocks. Also, only 5% of do-it-yourself investors get a passing grade in their level of financial knowledge. Paradoxically, 64% of them believe to be competent in portfolio management.
In this context it is important that do-it-yourself (independent) investor be objective in its self-evaluation. Most do-it-yourself (independent) investors should avoid doing stock selection.
Solution : Using ETFs allows to build basket of securities with little effort, and at a low cost, but it is important to choose a combination of ETFs that are appropriate to an investor's profile.
For all the reasons listed above, the performance of do-it-yourself (independent) investors' portfolios are generally lower than indices. With our Do-It-Yourself Service, Idema Invesments automated system handles all these issues. You can benefit from a professionnally managed portfolio while executing the trades yourself.
For more infomation, visit the Do-It-Yourself Service page.
Sources: Idema Investments Research, Carpentier, C. and J-M. Suret (2011), TMX Group, Service Canada
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