4 Fundamental Reasons Do-it-Yourself Investing Fails Miserably

Nick Hodges, CPA/PFS, MBA, CFP

Like a gambler seeking a big win at a Vegas casino, do-it-yourself (DIY) investors think that a ‘win’ during a bull market is an indication of their own good judgment. Believing the media dream that with the right research and trading platform, they can beat the market and produce astronomical gains with their hard-earned savings. These DIY investors forget that in a bull market EVERYONE wins.

Upon closer examination, another picture is painted. With every move of the market, DIY investors buy high and sell low, riding an emotional rollercoaster that is dependent on the performance of the current “hot tip” of media investment gurus. When it comes to critical information associated with their investments, DIY investors major in the minors and miss important sectors of information that can save them money and protect their future. Risk only means something to a DIY investor AFTER the market drops because they have taken on WAY too much risk, chasing returns with a get-rich-quick mentality. In a bear market, DIY investors suffer most as each mistake snowballs into a failure that jeopardizes or eliminates their future financial security. For many, they are unable to recover from these errors in time for retirement.

Mistake #1: You are emotional about your money.
Dalbar Statistics. Since 1994, Dalbar Inc. has issued an annual Qualitative Analysis of Investor Behavior (QAIB) report, which measures the buy and sells behavior of individual investors. These reports have consistently documented the inability of the individual investor to make nearly the returns that mutual funds advertised, mostly because they buy and sell too often and at the wrong times. Lou Harvey, President and founder of Dalbar recently commented, “...Mutual fund investors do not achieve the returns cited by fund firms due to their irrational behavior.” This is a succinct assessment after fifteen years of measuring investor behavior.

Contrarian Investing. DIY investors are SO emotional about their money, that there is an entire sector of investing professionals that routinely invest OPPOSITE of the individual investor. A contrarian understands that there is great opportunity to buy or sell specific investments when the majority of investors appear to be doing the opposite, because that investment has become mispriced due to the investors’ overall emotional response to the market. Well-known financial pundits Warren Buffett, David Dreman, and John Neff promote Contrarian Investing. This realization should make every DIY investor reconsider their ‘objectivity’ in singularly managing their own financial affairs.

Mistake #2: You think you have access to valuable research and information.
You think that with all the online research tools and media commentary, that you are receiving noteworthy information about managing your investments yourself. The truth is, by the time you read it on the Internet, or hear it on the nightly news, industry professionals have already acted on the information and gained the benefit of acting first. Additionally, your information is usually second-hand, ‘spun’ by the media to make an interesting story, not provide sound financial advice.

As a DIY investor, you are competing with an entire industry of investment professionals for information and position in the market. This industry invests millions of dollars and employs thousands of researchers to provide the best, most up-to-date information for their stock traders and money managers. As a result, these professionals act well before you can, leaving you at the end of the investment food chain, consistently putting a DIY investor in the position of buying high and selling low.

The worst part of trying to be your own research specialist is that the DIY investor tends to major in the minors, focusing only on information that they can readily understand. DIY investors, who involve themselves in intense information overload of conflicting advice, finally retreat, focusing only on numbers they understand, instead of analyzing the right numbers for their financial picture. In nearly three decades of tax preparation, I have seen pages of stock transactions that resulted in nothing but trading fees for the stockbroker, investment decisions made on internal costs instead of proper asset selections, and investment choices resulting in more taxes due, rather than less. In each situation, LOSS was the end-result for the DIY investor, not gain.

Mistake #3: Your investment choices are not integrated with your financial world. Managing your financial world is not simply knowing how an investment is performing in the market, that is something every DIY investor can easily figure out. It is about understanding how this particular investment will AFFECT your unique financial world and your future. What will happen to your tax projections? What about your retirement? Will this money be available to you when you need it for retirement? What if you need it BEFORE retirement? Do you know how to protect your retirement lifestyle by protecting how much you will need in retirement? What about your lifestyle today? What about your estate? What if something happens to you before your investment dreams come true? Do you know the how and why answers of your financial world with respect to insuring what you cannot replace? How do you want your children or grandchildren to benefit from your decisions? Do you have the legal background to know the best structure in which to place your investment? When do you need a trust? What kind of trust is best for you? Do you own a business? Do you know what you want that business to do for you in retirement, for your family? (This is only a small sampling of questions associated with integrating your financial world and investments.)

Answers to questions concerning the integration of your entire financial world do NOT lie somewhere in the internet stratosphere; the DIY investor can easily find facts and opinions on the internet. However, what is missing is the educated and experienced judgment of a financial professional that KNOWS the DIY investor’s unique financial situation AND the various financial, regulatory, and tax arenas. Missing critical links between investments, tax, legal, banking, real estate, retirement, and family legacy arenas costs DIY investors and their heirs thousands of dollars and uncounted hours of emotional distress every year.

Mistake #4: You take on too much risk. The DIY investor typically measures their success by measuring investment returns instead of measuring their goals and resources for the future. Comparing only investment returns without regard to potential volatility and risk reveals the Achilles’ heel of the DIY investor: Greed. A ‘more is more’ mentality can be hidden in an up market because risk is rarely active. However, the moment that the market downturns, that risk factor precipitates, and the DIY investor is faced with unnecessary loss predicated by that very greed, having risked more than was necessary to reach their financial goals.

A DIY investor recently told me how they wanted to invest their money:

“We want a conservative portfolio with a moderate to aggressive strategy…nothing too aggressive/risky but still somewhat aggressive. My wife wants funds with oil and copper investments.”

Chasing returns, they wanted all of the upside of the market and none of the downside. Instead of asking how much of a return they can rake in, a DIY investor needs to be asking how much risk is necessary and appropriate to reach their GOALS. However, if the goal is ‘more is more’, the DIY investor is always going to risk their nest egg to seek the highest possible return. No matter how much research a DIY investor uses to rationalize their choice, this is like playing Russian Roulette with their money. This is NOT investing, this is gambling.

DIY investors typically are bright, informed, and misguided into thinking that they can beat the market and save money by being a lone ranger. What they really want is to feel smart and in charge of their world. What they need is to be working with a financial professional that can put all the pieces of their dream together, educate them on their options, and prevent them from making mistakes with their hard-earned money.