Whether looking to upgrade the kitchen, find a new job, or decide which positions to buy for a 401(k), you must decide: should you do it yourself or consult a professional? While the dangers of trying to do your own electrical work are more evident, do-it-yourself (DIY) investing also carries risks for those who aren't careful.
According to a recent study by Deloitte, 52% of respondents were not working with a financial professional for retirement planning, saying they preferred to handle it themselves. Note however, that of those who opted for professional services, 60% felt "very secure" about their retirement, compared to only 32% of respondents who were managing their own retirement investments.
What might account for this large gap? Let's review three of the pitfalls of do-it-yourself investing.
#1 - Investing without a plan
One of the common mistakes DIY investors make is failing to create a proper plan before they invest, and sticking with it after they've started. Without considering their risk tolerance, time horizon, and appropriate asset allocation, investors could be exposed to too much - or not enough - risk given their financial goals. Even when an effective asset allocation of diversified investments is implemented, neglecting to re-balance a portfolio to maintain the optimal asset mix will undermine the original strategy. Of course, if an investor does remember to re-balance, but has created an asset allocation based on flawed assumptions, that creates problems as well.
#2 - Overlooking Tax Implications
Taxes are complex, and investors don't always realize the tax implications behind their investment decisions. Nearly every financial decision has the opportunity to create a taxable event - either now or in the future. The DIY investor may not realize the higher dividend payout in a particular ETF could result in an increased tax liability that year if held in a taxable account. This is only one small example - strategic tax planning spans all aspects of your financial life.
#3 - Performance, Performance, Performance
Of course performance is important - it is a central reason we all invest. But independent investors often chase performance, which can lead to poor investment decisions, bad timing, and actually a worse overall return. Even in well-performing investments, future returns are only speculative. Moreover, the asset may not be an appropriate investment given your personal risk tolerance and current asset allocation. When investors chase performance, they tend to buy high and sell low. Not only is this an ineffective strategy for producing satisfactory returns, excessive trading leads to unnecessary fees and could potentially trigger a tax liability.
Investing can be complicated, both fundamentally and emotionally. It can be difficult to weather market volatility when you can't make decisions objectively. If you're a do-it-yourselfer and are considering working with a financial adviser, do your research first. Not all advisory firms are the same - only a firm that is a Registered Investment Adviser (RIA) has a fiduciary duty to act in the best interest of their clients.
The material contained in this article is for general information only and should not be construed as the rendering of personalized investment, legal, accounting, or tax advice.
To learn more about Thomas McFarland, view his Paladin Registry profile.
Previously posted on Paladin Registry.
About the Author: Tom McFarland is a Certified Financial Planner™ practitioner and the President and Founder of The Darrow Company, Inc., a fee-only registered investment adviser based in Massachusetts. Tom founded The Darrow Company in 1987 to be a selective wealth management firm that could provide honest advice and tailored options to meet the needs of a diverse client base. Tom has been involved in the larger financial community by serving as Chair of a local chapter of the Financial Planning Association (FPA). He is a member of the National Association for Personal Financial Advisors (NAPFA) and the National Association of Tax Professionals (NATP). Follow Tom on Twitter @DarrowWealth