The pitfalls of DIY investing

1 Nov

Author: Hannes Smuts

Publications: PSG Konsult

Date Published: 1 November 2013

This is a warning. Yet, regular readers need not fear: this is not an alarm bell sounding the dangers of another investment scheme promising unrealistic returns. For most, the name Herman Pretorius should ring a bell. Obviously that threat remains ever present, but there is a much more subtle trend that needs to be recognized. We call it DIY investing. Let me explain:

Hardly a day goes by that people with funds to invest are not bombarded by advertisements and other communication prompting them to manage their investments themselves. The nature and content of these ads might differ, but the message is the same: you do not need the input of an investment professional to invest on the stock market or to guide you towards a sensible investment plan tailor made for your unique situation.

Does the following sound familiar? Cut out “the middleman” and become a stock market entrepreneur (more likely millionaire) – we will give you 3 share tips to start your millionaire portfolio. Such exhortations appear continuously on television, in the printed media and via electronic communication.  Interwoven into these campaigns is the emphasis on the relative ease with which one’s affairs can be conducted online.

On the face of it DIY investing has become child’s play. The perception is created that most people can manage their own investment affairs without incurring the “extra costs” of a professional investment advisor. The message reverberates: professional advice has become too expensive and redundant. Do your investments, including purchases of unit trusts, online! Oh yes, and if you want to save even more money, skip the asset manager (and his unnecessary fees) as well by going for a really “cost effective” index tracker.

It is to be applauded that technological advances during the last decade have opened up new avenues for making informed investment decisions. However, it is the way this is being portrayed, combined with the inherent lurking risks, which need to be addressed.

We have identified mainly two dangers. The first is that DIY investment encourages short term thinking. The second is that it almost certainly does not address the risks created by investor behaviour.

Markets that generate positive returns, especially during a long upswing, are known as bull markets. Statistics have shown that bull and bear markets lead to irrational investor behaviour.

Think back to the bull run in the residential property market between 1995 and 2006. For a decade, returns were not only around “20% p.a”., but also a dead cert. The natural consequence was that everyone and anyone that could, started trading in property and made money. When finances were discussed around the braai fires reassuring remarks abounded such as: property prices don’t drop – they might move sideways, but never down!

Investors conveniently ignore the past which would have taught them that property is as cyclical an asset class as other growth assets. The rest is history: the property market contracted by as much as 30% to 40% in a year and many speculators were left stranded. It took years for the residential property market to show signs of recovery and guess what: most “investors” now believe it’s a bad investment.

What has this sad story got to do with cheap and convenient DIY investing?

Generating good, inflation beating investment returns in South Africa (and even abroad) has been fairly easy for the last 10 years. The reality is that these returns were driven by a rampant bull run on the JSE. Therefore one cannot really blame those who have ventured into DIY investing and for spreading the word about their successes.

Reality is that most investors who have been in the markets during the last 10 years have yet to experience the pain and frustration of a bear market. Unless they have a good understanding of the risks involved, and in particular the interaction between risk and reward, they will be well advised to use professional investment advice.

But you do not have to take only our word for it. In a recent article on 21st Century Megatrends, well known future-scenario planning expert, Clem Sunter, suggests that retirees will still need “an astute financial adviser”, otherwise, as he puts it, it becomes a race between poverty and death.  This remark should not be limited to retirees.

Note: This article does not constitute formal advice. Past performance is not indicative of future returns. Always remember the prudent way is to consult your stockbroker before investing.

Hannes Smuts is a senior portfolio manager at PSG Hermanus Portfolio Management & Stockbroking.

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