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(John Sopinski/The Globe and Mail)
(John Sopinski/The Globe and Mail)

PORTFOLIO STRATEGY

Nailing it: Nine essential tools for the DIY investor Add to ...

Mistakes will be made when you’re a do-it-yourself investor.

But if you have a big-picture understanding of what you’re doing, you’ll make out fine. How can you tell if you have the right skill set to manage your own money? Here are nine qualifications for successful DIY investing, as suggested by Robert Stammers, director of investor education for the CFA Institute, which oversees the respected Chartered Financial Analyst (CFA) designation.

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1. You have discipline as an investor.

How to undermine a good investing plan: React emotionally to big stock market declines by selling, and then buy back in as the market reaches new highs. Think back to the market crash of 2008-09. Were you panicked into selling, as many investors were? Are you still waiting to calmer conditions before you get back in?

Mr. Stammers says DIY investors need to be brutally honest about their emotional commitment to sound investing principles like creating a sound plan and following it through up and down market cycles. “If you’re going it alone, you really need to understand your own biases and what you’re likely to do in certain situations.”

2. You understand your risk tolerance.

Mr. Stammers says you first have to understand what this term even means. In the financial industry, risk is often equated with volatility, or the tendency for a fund, stock or bond to move both up and down in price. For individual investors, risk is often, and appropriately, defined as the potential to lose money.

People must accept some risk of losing money if they want to make more than they can with risk-free investments such as Treasury bills or high-interest savings accounts. The question DIY investors must answer is how much they can stand to lose in a year to pursue potentially higher long-term returns. The S&P/TSX Composite Index lost about 33 per cent in 2008, but made 4.8 per cent annually in the past five years and 8.4 per cent annually for the past 10 years (all returns include dividends and share price gains).

3. You understand asset allocation.

“On average, I don’t think people do a very good job at this,” Mr. Stammers says. “A lot of people think of investing in terms of buying stocks, or buying products.” Asset allocation, or the blend of stocks, bonds and cash, is crucial, though. He adds that there’s research indicating that it may be more important in explaining returns than the selection of securities.

Google the phrase “asset allocation tool” and you’ll find plenty of calculators to play with. Try several as the results will vary. And make sure you use a Canadian calculator – the U.S. ones won’t generate relevant information.

4. You understand your investment goals and constraints.

Mr. Stammers says your goal is your purpose for investing – it might be retirement, or paying for your children’s university or college education. Retirement investing suggests a long-term approach over decades, while investing in a registered education savings plan, or RESP, compresses your timeframe and thus requires a different mindset.

Constraints on your investing might include avoidance of high-risk investments such as speculative growth stocks or high yield bonds. Or, they might play out as a socially responsible investing stance, where you focus on the best corporate citizens and avoid companies in businesses like arms, tobacco and nuclear energy.

5. You’re able to read financial documents.

“I think it’s important that people understand a prospectus,” Mr. Stammers says. “If you’re going to be a do-it-yourself investor, you need to understand where the risks lie.” Warning: Outside the mutual fund industry, prospectuses are infested with jargon and largely unfriendly to individual investors. You may need to do further research to understand what you’re buying.

Mr. Stammers said a rudimentary understanding of financial statements is desirable if you’re going to invest in individual stocks. For example, he suggests having an understanding of cash flow to see how a company is deriving its earnings, and what the potential is for future growth. Other areas of interest include debt levels, cash balances and the ability to sustain and grow a dividend.

6. You can make an educated choice between active and passive investing.

Active investing means using mutual funds run by professional money managers, or buying and selling stocks on your own. Passive investing, where you own index-tracking exchange-traded funds (ETFs) or mutual funds, is a simple process and thus a much cheaper way to invest for DIY investors than mutual funds.

Mr. Stammers says that more and more people are building simple portfolios with just a few ETFs. “This is very popular right now, and it’s appropriate for a lot of individual investors, especially those who are starting out.”

7. You know what style of investing you’ll use.

Your style may be to emphasize income from dividends and bond interest instead of growth in the value of the securities you own, or it may be favour fast-growing companies or undervalued ones. A style that Mr. Stammers sees a lot of people using is called core and satellite, where you have a stable, long-term focus for most of your money and a small allocation to higher risk investments.

8. You understand how and when you will seek help.

Mr. Stammers said that while some people know how to put a portfolio together, they may not have the broader financial planning knowledge needed to set and achieve their investing goals. The answer could be a financial planner who charges a flat or hourly fee to produce a big-picture financial plan.

“If you don’t feel comfortable with financial planning or if you don’t think you’ll do a good job, I think it’s money well spent to have a plan together. That’s really what’s going to set you on the right course.”

9. You can navigate the market alone.

Mr. Stammers said you’ll need a trustworthy source of information on the markets and investments. Given that investment firms do an uneven job of reporting your returns, you’ll also need to have a way of measuring how your money is performing. (My suggestion: Try the Watchlist and My Portfolio features on Globeinvestor.com to track individual securities and your entire portfolio.)

Mr. Stammers says the best way to gauge your returns is to compare them to the correct benchmark. Examples: The S&P/TSX Composite Index for Canadian stocks or the DEX Universe Bond Index for bonds.

 

Read more from Portfolio Strategy.

For more personal finance coverage, follow Rob Carrick on Twitter (@rcarrick) and Facebook (robcarrickfinance).

Follow on Twitter: @rcarrick

 

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