Why Manage your nest egg Yourself?
Why would anyone manage their own stock portfolio? Why would you want to? The prime reason, for becoming a self-directed investor is you want a better net return. The two routes to a better return are increasing gross return and reducing investing expense. Investing expense is the gap between gross return and net return.
Investing Expense
Investing expense, the expense of having a stock portfolio, includes commissions, management fees, annual fees, quarterly fees, inactivity fees, planning fees and slippage. The most tangible argument for do-it-yourself portfolio management is lower investing expense. Doing it yourself predictably reduces future investing expense. Switching from a full price broker to an online broker reduces commission cost. Making your own buy/sell decisions eliminates management fees. The lower you can drive investing expense the smaller the gap between gross return and net returns.
Berkshire Hathaway Inc. — 2004 Annual Report
By Warren Buffett
... Investors should remember that excitement and expenses are their enemies. ...
Slippage is the price change from decision to buy/sell and execution of a trade. Fast online discount brokers often have less slippage than full service trade-by-phone brokers. Some slippage might come from brokers skimming or trading their own accounts. News about lapses in mutual fund management ethics is very discouraging. However, most slippage comes as prices move in the time between decision point and trade point. Faster execution reduces slippage.
Few pros charge based on how much your account has grown. Fewer pay you if your account shrinks. Mutual fund managers may even increase their fee rate if fund asset base is falling and they can’t cut management costs. Unfortunately, some of the firms that started performance based fees ran into trouble with the SEC. They ran into trouble for cheating not for having performance based fees.
That mutual funds charge to look after your money is no secret. Sometimes the total investing expense they are adding is not obvious. The following quote is lifted from a report to federal employees on their retirement system.
Informed Investor: Understanding Mutual Fund Expenses
By Edward A. Zurndorfer
...
For example, Lipper found that with one fund it analyzed the fund disclosed that 1.97 percent of its assets are used each year to cover the fund’s expenses (referred to as the “expense ratio”). When “brokerage commissions” of $7 million are added, the cost of ownership in the fund to investors increases to 5.8 percent a year. In other words, if the fund’s investment performance before expenses indicates an annual investment return of 9 percent, then the actual return (after expenses) to investors is 9 percent less 5.8 percent, or 3.2 percent.
...
Return
Return is yield. Gross return is the increase in an investment, in one year. Net return is the bottom line, the amount your account has grown. Net return is gross return less investment expenses. Future gross return is less certain than future expense. Return goals can be stated relative to the markets. This takes market variance out of performance measures. Some strategies 'beat the market'. Some pro money managers 'beat the market.' Some self-directed investors 'beat the market.'
Pro money manager returns and self-directed returns overlap. Some pros beat some do-it-yourselfers, and vice-versa. There is little consistency from year to year. A pro with a stellar 2004, may not have a good 2005. On average about 1 in 5 pros beat the market. On average about 1 in 5 do-it-yourselfers beat the market. How is it easier to find the 1 in 5 pro who will beat the market than to find a stock that will beat the market?
Individuals can self manage portfolios to 'beat the professionals' and to 'beat the market'. However, lowering investing expense is more predictable than increasing gross return. Getting a better gross return is not the slam-dunk reducing investing expense is. Getting a better return requires effort to learn, to pick strategies, and to trade with discipline
Non-Financial Considerations
Some of the reasons for being a self-directed investor go beyond financial.
Anonymity
With self-directed portfolios no one has to know your financial status. No one needs to know enough to want to share your wins or make fun of your mistakes.
Control
With self-directed portfolios no one stands between you and your money. The self-directed investor doesn't hesitate to pull out $100,000 for the down payment on a house, when he knows he isn't reducing his portfolio manager's income by the 2% annual management fees ($2,000).
The self-directed investor doesn't get sold on buying stories (stocks) when they don't fit his portfolio strategy. He/she doesn't get or act on hot tips. He takes pride in having a plan and working the plan.
Autonomy
The self-directed investor doesn't have to follow the crowd. This investor has a plan that gives him independence.
FUN
Self-directed investing has some of the features of gambling, with a smaller House Advantage.