Every Canadian with basic computer skills and moderate financial literacy should theoretically be able to manage their own investments. The key to designing an effective investment portfolio relies on proper identification of your risk profile and personal situation. But should you take this on this huge responsibility yourself?
Here on The Rich Moose, I chose to share a portfolio I believe will provide great long-term performance. However, this 4-ETF portfolio is not perfect for everyone; it is an aggressive, but simple portfolio designed for people with higher-than-average risk tolerance.
The RM Balanced Portfolio would not be ideal for someone in retirement, for example, as it does not mitigate sequence risk and is not tax-efficient for people drawing income off the portfolio.
Honest evaluation of your risk profile is an important first step. It is pointless to build a portfolio and manage your own investments if you can't stick to your investment plan.
Here are some great questions to ask yourself before taking on self-directed investing:
- How long will it be before I plan to withdraw from my investments?
- Less than 5 years
- Between 5 and 15 years
- More than 15 years
- How long do I believe I should hold onto an investment after I make my purchase?
- Until it is clearly not doing as well as it should be
- To the extent it fits my overall investment plan
- What is the appropriate action to take when the stock market drops more than 20%?
- Sell my stocks and move to bonds/gold to avoid further losses in a bad market
- Don't make any trades at all and wait things out
- Sell bonds/gold to buy more stocks up to the limits of my investment plan
- Is it reasonable to expect lower investment returns in exchange for more stability?
- I believe good investors can get great returns and stability by choosing the right investments
- I know less risky investments are not as lucrative over a long time period, but stability is important
- Stability is not important to me because I have a good understanding of different investment products and their history
- Is it OK to change some of my investments based on a discussion with a knowledgeable friend?
- If my friend is successful I should seriously listen to what they say and make appropriate adjustments
- I believe I should stick to my investment plan and ignore "the noise"
- Every bit of knowledge should be thoroughly evaluated
- How often do I check my investment portfolio?
- I check my investments several times a week to make sure everything is on track
- I check my investments a few times a year
- I check my investments once or twice a month
- Do I get excited when I see my portfolio doing well?
- Sure, it's evidence my investment strategy is working
- Not really because I know market crashes come after stock market bubbles
- It doesn't really matter to me
- How long have I invested in stocks/bonds? Would I consider myself to be knowledgeable about investing?
- I'm just getting started and/or I don't know the difference between an ETF and an index
- I have been investing with an advisor for a while and/or I can explain the success rate of active managers compared to indexing
- I have long self-managed my investments and/or I understand the difference between a long put option and a short put
Scoring schedule: see bottom of article. Make sure you complete the questions honestly and mark down your answers before checking your score.
There are investors out there who simply should not manage their own investments. For these people, they would be best off using a financial adviser who charges a maximum 1% fee and directs them to low-cost ETF-based portfolios with an average MER under 0.20%.
While a good financial adviser will not be able to promise outsized investment returns, they will prevent you from making costly mistakes. In this case, the 1% fee is much cheaper than the potential of losses caused by bad investor behaviour.
Investor behaviour is a huge influence on performance. Several comprehensive studies have found the average American investor in the last few decades would have achieved better results simply buying intermediate-term government bonds than poorly attempting management of a diversified portfolio.
For investors who want to self-manage but score on the lower end of this questionnaire, they should strongly consider developing a more conservative investment strategy, writing down their investment plan, limiting the number of investments held, and take great care to stick to their plan. This could be similar to the RM Balanced Portfolio, but with a higher allocation to bonds and lower allocations to stocks.
Investors who score high on this questionnaire should still develop an investment strategy and write it down. They can move to more aggressive allocations and, if their assets are greater than $500,000, diversify over a few more asset classes. They could also consider more aggressive strategies like Trend Investing if they are very aggressive savers, have a good understanding of rules-based investing, and have long-investment timelines.
It is important to point out not all aggressive, or complex, investment strategies are good and they don't necessarily provide better returns. This advantage might be more dependent on the character and knowledge of the investor than the plan itself.
Personal circumstances are the first important factor in portfolio development. If you are retired, or close to retirement, you should have a very different looking portfolio compared to someone who is decades away from retirement.
Taxes play the second factor and this is related to province and income level. High income people, or moderately high income people in high tax provinces, should invest with a careful eye to tax efficiency. This means use of swap-based ETF products, minimal trading to avoid tax triggers, and maximum use of capital loss opportunities.
Lower income people, or those with comparatively low marginal tax rates, can invest in income generating products without realizing big tax costs.
Other personal considerations are longevity, spending flexibility, and the required income as a percentage of your portfolio when retired. People with shorter lifespans, considerable spending flexibility, or low withdrawal requirements can afford to invest more aggressively as they are not as susceptible to sequence risk.
Questionnaire Scoring Schedule
Add up the points for each italicized answer. Answer 1 = 1 point, Answer 2 = 2 points, Answer 3 = 3 points.
If you scored between 8-12, you should strongly consider investing with a financial planner. Despite their cost, they are likely to help you do much better than you would otherwise.
If you scored over 13, you can consider self-directed investing. Take great care to stick to a well-developed and simple investment plan. You may want to confide in a knowledgeable, experienced investor friend and talk to them before making trades which significantly deviate from your investment plan.
If you scored over 19, you are likely suited to more aggressive self-directed investing strategies. Develop a plan and use your knowledge and comfort with investing to your advantage. Be careful not to fool yourself because of your knowledge.