The internet has transformed our lives, including how we buy stocks. Before, it wasn’t very easy, involving brokers and specialists. But in 1983, a dentist in Michigan changed everything by making the first online stock transaction using a system now owned by E*TRADE Financial.
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Today, online brokers and easy access to financial data make investing as simple as opening a savings account. But in this internet age where we do things ourselves, is investing something we can do on our own? If it is, why not just ditch your financial advisor, pay lower fees to mutual funds, and manage your portfolio? We’ll explore the basics of managing your money before taking on the role of your financial manager.
KEY TAKEAWAYS
- The abundance of online information might make new investors feel overly confident without enough experience.
- Understanding modern portfolio theory and risk is crucial for successful investing.
- Observe the market to learn its behavior and how it responds to daily events before diving in.
- Create a virtual paper trading account to practice without risking too much money.
Should You Manage Your Own Money?
William Porter’s first trade revolutionized how investment products are researched, discussed, bought, and sold. Computerized trading has made markets highly liquid, making buying and selling securities quickly easy. Now, DIY investors have access to free financial data used by professionals, and sites like StockTwits connect communities of investors in real-time.
But is managing your money a good idea just because it’s possible? Professional investors warn that the stock market can be costly to learn. They know it’s easier to lose money than to make it, and the wealth of information available may create a false sense of security for inexperienced investors.
Tools are only as effective as the user’s knowledge and experience. Can high-priced music software make beautiful music without skilled composers? Can the latest surgical technology turn someone without training into a top surgeon?
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While the internet has provided retail investors with the tools to manage their money, having the necessary knowledge and experience to use them effectively is crucial. What fundamental knowledge should investors have before parting ways with their financial adviser?
Modern Portfolio Theory
Understanding the modern portfolio theory (MPT) and how asset allocation is determined based on individual factors is crucial. MPT isn’t just about allocating assets and ensuring they are done efficiently. Skilled money managers know how to position your money for maximum return with minimal risk, considering changes in your financial situation as you age.
Risk tolerance is also important and can change at different stages of life. For example, as you near retirement or have other financial goals like saving for college or starting a business, your portfolio needs to be adjusted accordingly. Financial advisors often use special software to create detailed reports that retail investors cannot access.
Understanding Risk
In the world of free resources, risk is often underestimated. The term “risk tolerance” is used so much that retail investors might think they understand it if they know investing can mean occasional losses. But it’s not that straightforward.
Risk is a complex concept that’s hard to grasp because investors don’t always act in their best interests. A study found that inexperienced investors often buy when prices are high and sell when low, leading to losses in short-term trades.
Important: Understanding risk can be difficult because investors sometimes make decisions that aren’t in their best interest.
Understanding one’s true attitude toward risk is challenging because it’s a behavior that can be hard to assess accurately. Day traders, who have a high tolerance for risk, might have a low tolerance because they avoid holding investments for long. Successful investors know that making decisions based on facts, not emotions, is key. But it’s tough to do this when dealing with your money.
Can You Beat the Market?
How likely is it to beat the overall market? It’s like asking how likely a football player is to be the best in the NFL for decades. The efficient market hypothesis (EMH) suggests that all available information about an investment is instantly reflected in its price. So, if a company like Intel announces lower sales, the stock price immediately adjusts. According to EMH, consistently outperforming the market is nearly impossible because prices already reflect true value.
It might work in the short term for retail investors who pick individual stocks hoping for big gains, like gambling, which sometimes pays off. However, as EMH proponents argue, this strategy has often failed over the decades.
As noted by investor Charles Ellis, even top investors with global research teams struggle to beat the market consistently. Critics mention investors like Warren Buffett, who beat the market regularly, but what does EMH mean for regular investors? Before deciding on an investment strategy, you need solid knowledge and data to support it.
If you’re betting on individual stocks to rise faster than the market, what evidence supports this? Is there proof that an income strategy focusing on dividends works? Or would investing in an index fund be better? Where can you find the data to make these decisions?
Learning to Invest
What’s your job? Some people say their skills come from experience, not their college degree. When you started your job, were you good right away?
Before you manage your money, you need experience. But learning as an investor often means losing money, and that’s risky for your retirement savings.
Experience comes from watching the market and how it reacts to daily events. Pros know the market changes all the time. Sometimes, it overreacts to news, and other times, it ignores it. Some stocks change a lot, while others don’t.
For beginners, a virtual or paper trading account is great. You can learn without using real money until you’re ready.
The Bottom Line
Many people have succeeded in managing their own money, but before taking risks, learn about investing first. Would you recommend it if someone wanted to do your job based on what they read online? If you were looking for a financial advisor, would you hire yourself based on your current knowledge?
You might say yes, but until you have the skills and experience, it’s better to let professionals handle your retirement money. Managing a brokerage account with money you can afford to lose is okay, but leave your retirement savings to experts.
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