More DIY investing challenges

Unrealistic expectations. Anyone who works with an adviser completes a risk tolerance questionnaire, and the process is revealing. Investors often say they want an expected return of 6% to 7% (occasionally we get people who expect 8% or more) while also indicating they’ll accept no more than a 10% loss in any given year. Those goals are incompatible.

With bond yields under 3% today, a balanced portfolio of 60% equities and 40% fixed income probably has an expected return of about 5% before fees, and in a scenario like 2008–09 it could suffer a drawdown close to 20%. Unless investors understand these trade-offs they can’t hope to carry out a long-term plan.

Ignoring asset location. Most people understand Canadian equities should be held in a non-registered account (if there’s no registered room available), while bonds are best held in an RRSP or TFSA. But there are subtle asset location issues most DIY investors are unaware of—indeed, even many advisers pay no attention to these details.

As I’ve written about before, US securities are exempt from foreign withholding taxes in an RRSP, but not in a TFSA. And if you need to hold fixed income in a non-registered account, GIC rates are far more tax-efficient than bond funds. Investors anchor on fees because these are easy to compare. The cost of paying unnecessary taxes is much less obvious, but it can have a much bigger impact than fund MERs or fees paid to an adviser, especially for wealthy investors.

Currency conversion. Currency spreads at discount brokerages are outrageously high: on transactions under $50,000, a spread of 2.5% is not unusual for a round trip. DIY investors who buy US stocks or ETFs without taking steps to reduce the cost of currency exchange can easily lose hundreds of dollars on a transaction. Norbert’s gambit is a great solution but it’s hard to pull off unless you have a lot of experience trading with an online brokerage.

Inability to tune out the noise. We all react emotionally to financial headlines: being fearful during a market crash or exuberant during a bull market is just part of being human. But successful investors need to restrain themselves from acting on those emotions. DIY investors face a tough challenge, because technology makes it so easy to trade: many brokerages now even let you buy and sell on your smartphone. A long-term portfolio doesn’t need to be adjusted after every episode of Market Call, and there can be huge value in putting an adviser between you and your impulses.

Finding professional help. DIYers often ask me to recommend an investment adviser who charges by the hour, or one who will make specific investment recommendations they can implement on their own. The problem is, most licensed advisers want nothing to do with that business model. Even if they were inclined to work with do-it-yourselfers (and most are not) they would face hurdles from their compliance departments.

Financial planners may work on an hourly model, and they are helpful when clients are looking to manage cash flow, reduce debt, get the right insurance coverage or plan for retirement. But many have limited knowledge about investing, and most are not licensed to advise on specific securities. If you’re looking for someone to give you step-by-step instructions on how to design and implement an investment portfolio on your own, you’re not likely to get it from a fee-only planner. (For more on this distinction, see Preet Banerjee’s Find the perfect financial planner in the current issue of MoneySense.)

We have our winners

Many thanks to the 1,100 readers who entered the raffle for a copy of the new edition of my MoneySense Guide to the Perfect Portfolio. The five winners are Steve, Maxwell, Yasin, Trish and Stephen. I fully expect the other 1,095 readers to purchase a copy immediately!