Are you interested in taking control of your portfolio and becoming a “self-directed” investor within the stock market? If so then here is what you need to know.
An Overview of Self-Directed Investing
For most people the idea of self-directed investing comes with a myriad of misconceptions and fears but with the right information and knowledge, making your own decisions can produce significant results. It is not unusual, for example, for self-directed investors to outperform managed money and certainly with a good strategy you can produce well above average returns on a consistent basis.
In a nutshell, self-directed investing means taking the responsibility and control of the decisions surrounding your investments. By opening a self-directed online trading account, you retain the authority to choose the type of investments you want in your portfolio (e.g. mutual funds, ETFs, individual shares, etc), as opposed to ‘managed accounts’ where these decisions are made by a financial planner or an other financial professional. Managed accounts typically have a fee associated with them. (The industry average in Canada is about 2½% of your portfolio per year.)
Why should we self-direct?
So is self-directed investing for you? Knowing why you want to do something usually means you have spent some time looking at the pros and cons. For self-directed investing consider the following.
- Pros: More control and the potential for better returns, reduced fees, increased liquidity and greater capital appreciation.
- Cons: Investors assume the risk – and the emotional stress. Many also lack the time, knowledge, and discipline.
If you list out your pros and cons then you can work towards getting the answers you need to make an informed decision.
How much money do we need to start investing?
Many people believe that to self-direct an account, you need ‘lots of money’ but this is not true. You can self-direct any amount. For example, the new Tax Free Savings Account (TFSA) that allows Canadians over 18 to deposit $5,000 each year beginning in 2009, is eligible to be self-directed.
People with a large portfolio (e.g. $250,000 and above) often start by self-directing only a portion of it. There is nothing wrong with using the TFSA as a starting point. And as you become more knowledgeable over time, you can transfer a portion of your retirement savings plan account to a self-directed account without forgoing the tax deferral status.
Know What You’re Getting Into
Before you open your trading account and start putting your money to work, it’s important to take stock (no pun intended) of a few things. First, understand what you are getting into. Most Canadians express a sense of fear when it comes to making their own investment decisions and investing directly in the shares of companies doesn’t reduce that fear. The root cause of this fear, either consciously or subconsciously, often stems from a lack of knowledge on how the markets work and how successful they can be. People often think of investing in the stock market as gambling yet nothing could be further from the truth. If you were to ask those that have built great wealth utilizing the markets, you would rarely find “gambling” as a description of their activities.
For starters learn the terminology. A great resource is www.getsmarteraboutmoney.ca Developed by the Ontario Securities Commission, this website is a wealth of information on making and managing your own money. Then consider your options for education. If you are a novice investor with little to no experience a good foundation is important. Look for a company that provides a well-rounded learning experience and compliment that with your own reading and research. Think about how you have learned other skill-sets in your life and consider adopting that same process.
Create A Strategy
Part of your education should include the development of goals and a strategy including a trading plan that matches your risk profile. Setting goals means you can quantify your success at any given time against where you want to be. A good strategy will help you achieve your goals no matter what the market conditions are. And understanding your risk profile will protect you from making decisions that go against your tolerance level. Most novice investors get excited about making money because of course that is the point; however that by itself is not a good plan. A good education will teach you three important principles:
- Capital Preservation – keeping your money so you can invest it tomorrow and beyond.
- Money Management – knowing how to segregate your portfolio and your individual decisions.
- Risk Management – learning how to protect your capital if you make a mistake.
All of these need to be a part of your strategy and decision process.
Self-directed investing doesn’t have to be time consuming and it doesn’t require a million dollars but it does require knowledge — good goals, a good plan and a good strategy.