This article was first published in the National Post on July 3, 2021. It is being republished with permission.
by Tom Bradley
There has been a surge of do-it-yourself investors opening discount brokerage accounts and trading stocks. The trend towards DIY tends to be a cyclical phenomenon that emerges after long bull markets, but there are reasons why it has been more pronounced this time and could have staying power.
Technology has made trading easy, and commissions are extremely low. The information gap between professionals and amateurs has narrowed significantly. Some exciting new industries have emerged (cannabis; electric vehicles; space; alternative energy) and the well-known tech giants have been just so good.
If you’re doing your own thing, however, you shouldn’t totally dismiss professional management. There are some habits and disciplines you can borrow from the pros that will improve your outcomes. Let’s start with a few basics.
First, you need a roadmap. You need to know the purpose of every penny you’re investing, the time frame and how your stock portfolio fits with your other assets. In this go-go market, it sounds like boring stuff but when you hit air pockets or invariably make bad decisions, you need something to lean on.
Young investors shouldn’t skip the planning stage just because they have a small amount to invest. They need to understand there’s an opportunity cost to betting big and losing on speculative stocks or bitcoin. The math behind a more deliberate approach is compelling — starting early, making regular contributions and earning a market-like return compounds into real money.
Understand what risk means to you. The media tends to look at risk from the perspective of an older investor — i.e. market dips are bad. But if you’re accumulating assets and retirement is a long way off, your risks are very different. Lower stock prices aren’t a problem, they’re a godsend. Your biggest risk is overpaying for assets and as a result, not generating an adequate return to meet your goals.
Know how you’re doing. When I ask friends or clients how their portfolio is doing, I get vague answers. “Pretty well” or “Tesla has been great” or “Geez, I got out of the oils too early.” I’m left with impression that they don’t really know what their return is.
This isn’t good enough. Like the pros, whose results are public record, you need to be intellectually honest with yourself. Your overall results are what matter, not just a few big scores. An annual assessment of your after-fee returns is a must.
Check the price tag. The story behind a stock is easy to identify (i.e. blockbuster new product; geographic expansion; management changes). The hard part is figuring out how much of the exciting outlook is already factored into the price. What you pay for a stock is the biggest single determinant of how you’ll do, which is why fund managers spend tons of time comparing the valuation of a potential investment to its history and to other relevant companies.
Write down three reasons. Most managers have a discipline of writing down why they’re buying a stock. A few bullet points that explain the thesis and outline the key factors to watch for. The list comes into play when a stock is down and you’re wondering what to do. If the reasons for owning it are still intact, it’s time to buy more. If they’ve changed, you may want to sell and move on.
When it comes to portfolio construction, there are several things you can do to professionalize your process.
Make sure your portfolio takes different scenarios into account. This means not being too loaded up on one theme or trend. If you’re really excited about cannabis or electric vehicles, you should allocate 5 to 15% of the portfolio there, not 40 to 80%.
Likewise, if you’re convinced the market is heading south, lighten up on your riskier stocks, but maintain a meaningful equity exposure. You may be convinced of your view but be assured that for every compelling argument to sell, there’s an equally compelling one to buy. Diversification comes in handy when it turns out you’re wrong.
Leave room to buy more. As noted above, if a stock is down and the fundamentals remain strong, you can bring your average cost down by adding to the position.
And don’t be dogmatic about going it alone. A properly diversified portfolio needs exposure to areas that are difficult for an individual investor to access. Use ETFs and mutual funds in areas where you have no knowledge (international stocks) or need broad diversification (high-yield bonds). If you can’t beat ‘em, join ‘em.
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