By Dr. James M. Dahle, WCI Founder
I have a lot of people interested in being a DIY investor asking me how to successfully do it. They feel like they need just a little bit more knowledge to tackle it without an advisor. I’ve answered that question over the years by creating multiple tools to help you take charge of your personal finances:
- The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
- The White Coat Investor's Financial Boot Camp: A 12-Step High-Yield Guide to Bring Your Finances Up to Speed
- The White Coat Investor's Guide to Asset Protection: How to Protect Your Life Savings from Frivolous Lawsuits and Runaway Judgments
- Fire Your Financial Advisor! A Step-By-Step Guide to Creating Your Own Financial Plan
- Physician Wellness and Financial Literacy Conference
- Continuing Education 2022 Course: The Latest in Physician Wellness and Financial Literacy
- WCI Forum
- WCI Facebook Group
- WCI Reddit
- List of Good Financial Books
- 2,200+ blog postings!
However, in this post, I'm going to boil down the process of being a DIY investor in the simplest way I know.
Why Be a Do-It-Yourself Investor?
There are really three main reasons to be your own investment manager.
#1 It's Fun!
The first is that DIY investing is fun. If you detest it, you may want to rethink doing this on your own because you are unlikely to learn as much as you need to learn and unlikely to pay as much attention to it as you should (which isn't that much, but it does require some attention).
You get to be in control. Personally, I have zero tolerance for someone else screwing up my stuff. No advisor cares about my money as much as I do. I also get to completely eliminate the risk of my advisor ripping me off, as this once happened to a dentist in my neighborhood who no longer has a nest egg.
#3 Save Money
Perhaps the most important reason to be a DIY investor is to save money. Good financial advice is expensive stuff. It is silly to mow your own lawn, clean your own house, and work on your own car to save money and then turn around and pay tens of thousands of dollars per year to have your money managed. You would be better off learning to manage your own money and paying someone else to do those other chores.
How much does advice cost at typical prices? Well, consider a doctor who decides to save $80,000 per year for retirement starting at age 30 and pays 1% of their assets to advisors each year. By the time they retire at 60, their portfolio will be $1.5 million smaller ($9 million vs $7.5 million) if they used an advisor. If they live another 30 years, their portfolio stays about the same size over those 30 years, and they take out 4% a year to live, they will pay the advisor another $2.3 million in retirement. The way I look at it, if you can learn to be your own competent investment manager, you can make up to $3.8 million worth of mistakes and still come out ahead! Think of managing your own money as a very well-paid hobby.
Although I'm against bad financial advice and against overpriced advice, I am in favor of good advice at a fair price. The financial advising industry isn't hosing everyone and not all advisors are charging 1% AUM fees. Some advisors are better than others, and I've compiled a list of fairly-priced advisors that I trust to help you when needed. If an advisor can help you save and invest in a reasonable plan and can keep you from doing dumb things with your money (like bailing out in a bear market), paying a reasonable fee can be worth millions of dollars to you.
More information here:
Start DIY Investing Slowly
Managing your own money is easiest if you start doing it at the very beginning when you have hardly anything to invest. Your financial life tends to be pretty simple at that point. Your taxes are easy. You have few investing accounts available to you. Your portfolio might only be four figures or a low five figures. Mistakes made on a portfolio that tiny are extremely inexpensive.
But even if you're a few years into practice, you can still start slowly. You don't have to fire your advisor the day you decide to be a DIY investor. You can watch what your advisor does, ask lots of questions, and learn. You can also manage a portion of your money on your own—perhaps just your Roth IRA or just your 401(k) or just a 529 or just your taxable account, and you can see how you do and how much you like it. If you are like most, you will find it to be a relatively easy task and will soon feel comfortable managing the whole thing.
Some Learning Required to Be a DIY Investor
There are a few things a DIY investor must learn, either as education before you start or as part of your on-the-job training. Just as there is medical terminology, there is a specific language of finance. The more you deal with it and read about it, the more natural all of these words will be to you.
In particular, you should learn everything there is to know about your own personal retirement accounts. Your 401(k) is unlike that of anybody else (except your co-workers). Read the plan document. If your 401(k) is at Vanguard, read about all the investing options and fees. Read the prospectus of any mutual fund you are considering investing in. Compare one fund to another using the Morningstar database. Look up all the funds in your 401(k) there, specifically to see what they are invested in and what their fees are.
The good news is that you don't have to know everything about tax law or investing. All you have to know is the part that applies to you. Once you've learned that, very little changes from year to year, so you can automate a great deal of it down the road. Read a few books. Follow a good blog or podcast. Participate in an internet forum or two. This stuff isn't that hard to learn if you have even a little bit of interest in it.
Another important aspect of a DIY investor's learning has to be market history. I'm constantly surprised, particularly during a market downturn, how many people seem to have no idea what has happened in the past. They're surprised when markets go down 8% or 15% or 25%. They worry they should be doing something or that there is a problem with their investing plan. Reading and learning about market history allows you to ignore stuff like that. Not only has it happened before, but it happens all the time and is largely irrelevant to meeting your investment goals.
For example, from 1900-2013, there were 123 “corrections” (where the stock market drops 10% or more from previous highs) and 32 “bear markets” (where the stock market drops 20% or more from previous highs). What's the takeaway message? You should expect a correction every year and a bear market every three years. If you have a 60-year investing horizon (30-year career plus 30 years in retirement), you should plan to pass through 60 corrections and 20 bear markets. This is what markets do. It should not be a surprise to you.
Of course, there is no guarantee that the future will resemble the past, but market downturns should not change your investment plan because that plan should assume there will be tons of market downturns during your life as an investor. But again, this learning can all be done upfront. You don't have to redo it every year.
Invest You Must
Some people seek out an alternative to investing in risky assets. Unfortunately, for the vast majority of us, that simply doesn't work. It's not even an option. You MUST invest and you MUST invest in assets with some risk. The reason why is that riskless assets simply don't pay enough to reach any kind of reasonable goal. If you decide you're not going to invest in risky assets like stocks or real estate and instead will stick with bonds, CDs, or whole life insurance, you will need to save 50% or more of your gross income every year just for retirement. That's just not an option for most of us. You need to take significant investment risk.
There are two components to that risk:
The first, sometimes called shallow risk, is simply the volatility you will see in the value of your investment account between now and the time you need to spend the money. Although this does cause some people to have trouble sleeping, it is relatively insignificant in the long run.
The second risk, deep risk, is the concept that the value of your investments goes down and never comes back up due to inflation, deflation, confiscation, or destruction. For some reason, very few people lie awake at night worrying about those much more significant risks, and almost nobody lies awake worrying about the biggest risk of all—an inadequate savings rate. That's too bad, since that one is completely under your control.
Setting Appropriate Goals
The retirement savings game is a fairly simple math equation with a handful of variables. Start with a guess about how much income you will need in retirement. Don't worry about being perfectly accurate; you can adjust as you go. But look at what you're currently spending and adjust for those expenses which will go away at retirement and any new ones that might appear.
Let's say your guess is $100,000 per year. Then, subtract out any guaranteed sources of income, such as a pension or Social Security. Perhaps you're left with $70,000 per year. Now, multiply that number by 25. That's about how much you need to save for retirement. $70,000*25=$1.75 million. If instead you've only saved $300,000, you'll burn through that rapidly in retirement spending $70,000 of it each year.
Now that you have “your number,” you need to know how much to save each year. This depends on how long you have until retirement, how much you have now, and how much your investments can earn each year. Be sure to adjust your numbers for inflation. For example, if you invest aggressively, it is probably reasonable to assume your investments will earn 5% a year after inflation. If you need $1.75 million, want to retire in 15 years, and currently have $400,000 saved toward retirement, you can use the Excel PMT function to see how much you need to save each year. It looks like this:
You need to save $43,000 a year to reach that goal.
Choose a Simple Asset Allocation
The next step for a DIY investor is to choose an asset allocation, a plan for how you are going to invest your money. Since you need a 5% real (after-inflation) return, you will need to invest aggressively. That means most of your money should be invested in risky assets like stocks or real estate. The exact percentages don't matter all that much, but you want something low-cost, diversified, and with an appropriate level of risk—high enough that it will reach your goals and low enough that you can tolerate the volatility. There are hundreds of reasonable asset allocations. Pick one you like, write it down, and stick with it. Perhaps this will be your plan:
- 25% US Stocks
- 25% International Stocks
- 25% Real Estate
- 25% Bonds
Certainly, you can make your investment plan more complicated, and there may even be some benefits to doing so. Each of these major asset classes has sub-classes, and there are entire asset classes not included in the above portfolio. But once you get beyond 7-10 asset classes, you're just playing with your money a la Scrooge McDuck. As Thoreau said, “Simplify, simplify, simplify.” You don't have to invest in everything to be successful. Don't get paralysis by analysis. Remember that you can always tweak your plan later.
Be sure to write down your plan and the reasons why you built it as you did. Then, if you have doubts in a bear market, you can refer back to your written plan.
More information here:
Implement Your Investing Plan
Once you have reasonable goals and a target asset allocation likely to reach them, it becomes relatively easy to implement and maintain the plan. You obviously want to take advantage of any tax-advantaged accounts available to you. Let's say you put $20,500 into a 401(k) each year, your employer matches $3,000 of it, and you put another $6,000 for you and $6,000 for your spouse into Backdoor Roth IRAs. That is a total of $35,500. Since you need to save $43,000 per year, you will need to save another $7,500 per year toward retirement in a “non-qualified” or taxable account. Let's assume you currently have $20,000 in each of your IRAs now, $150,000 in your 401(k), and $210,000 in a taxable account, $60,000 of which is the equity in an investment property. Your investment accounts look like this:
- 401(k): $150,000 + $23,500 per year
- Your Roth IRA: $20,000 + $6,000 per year
- Spousal Roth IRA: $20,000 + $6,000 per year
- Taxable account: $210,000 + $7,500 per year
- Total $400,000
Since your desired asset allocation looks like this:
- US Stocks 25%
- International Stocks: 25%
- Real Estate: 25%
- Bonds: 25%
You can implement your plan like this:
- 500 Index Fund: $100,000
- Bond Index Fund: $50,000
Your Roth IRA: $20,000
- REIT Index Fund: $20,000
Spousal Roth IRA: $20,000
- REIT Index Fund: $20,000
- Investment Property: $55,000
- International Stock Index Fund: $100,000
- Municipal Bond Fund: $55,000
This setup has a number of benefits. Most 401(k)s have at least one index fund, usually an S&P 500 index fund, and some kind of a reasonable bond fund. REITs have relatively high expected returns but are very tax-inefficient, so they belong in some type of a tax-protected account. They may not be available in your 401(k), so the Roth IRAs are a good choice. All of the investments in the taxable account are relatively tax-efficient. There are other ways to implement this asset allocation into this particular investment account setup, but this is certainly a reasonable way to do it. Your own personal investment setup will have to be individualized to you, but once you write everything down in this format, it isn't that hard.
If you need help, you can meet with an investment advisor who charges by the hour or post it on the forum or the WCI Facebook Group for some feedback and assistance. Like setting goals, coming up with an asset allocation, and educating yourself, most of this work is done up front and then can be mostly automated.
More information here:
Stay the Course!
Maintaining the plan simply means making the required contributions each year, purchasing additional shares (or investment properties) as needed, and rebalancing the account from time to time, usually with new purchases.
Once you have a reasonable investment plan, the most important thing, perhaps just as important as your savings rate and far more important than your asset allocation, is sticking with the plan through thick and thin over decades. No plan will work if you cannot stick with it. If you can't do so on your own but you can do it with an investment advisor, it will be worth the money you will pay the advisor to help you.
What do you think? Do you think it is reasonable to be a DIY investor without an advisor? How did you come up with your investing plan? If you used to use an advisor and now do it yourself, what was the hardest thing about changing? What percentage of your colleagues do you think can handle their own investments competently? Comment below!
[This updated article was originally published in 2016.]