Congratulations on taking the decision to DIY invest. If you’re reasonably intelligent and disciplined, there’s no reason you can’t make the same, if not better, choices than a costly financial advisor.
We’ve identified these ten tools that will help fast-track you through the process, and help you realize your investment dreams – the tools in your DIY Investment tool belt, so to speak.
Tool #1 – Your Yardsticks
You need to get the measure of certain fundamentals before you can begin building your investment portfolio. You can’t measure progress without knowing where you’re starting.
Calculate your net worth by adding up your assets and subtracting your debts. You can do this on an excel spreadsheet, or find a plethora of templates on the internet like this one by Financial-calculators.com.
They also have an excellent budget calculator. Knowing how much you have available to invest every month is also essential.
Tool #2 – A Risk Assessment Tool
You will need some way of deciding on the split of bonds and stocks in your portfolio that is representative of your risk tolerance. The more risk-averse you are, the more you’ll want to be held in the relative safety of bonds.
There are various rules of thumb for retirement savings, such as “subtract your age from 100 and put that percentage in stocks,” or “own your age in bonds.” But there are reasons these rules should be amended over time. This article explains why investing 50% of your portfolio makes sense as long as you think you have more than fifteen years to live.
Regardless of the rules you choose to adopt, knowing your risk profile is critical. Try the Investment Risk Tolerance Assessment designed by Missouri University to see how you’re positioned.
Tool #3 – Advice from the Experts
When it comes to the selection of individual stocks, you need more than general rules of thumb. This aspect of DIY investing is what puts most people off. But it’s not necessary to spend hours every day reading the financial press.
Investing advice companies like The Motley Fool, started by brothers Tom and David Gardner in 1993, have consistently outperformed the market. For a monthly fee, subscribers get access to the brothers’ monthly stock picks and their analysis. Depending on your objectives, they have a range of products on offer.
Tool #4 – Power Tools (Robo-advisors)
The last decade has seen the maturation and proliferation of robo-advisors. Robo-advisors are computer programs that automatically buy and sell stock according to algorithms based on your risk profile.
The fees associated with robo-trading are significantly less than those of a human financial advisor. They also have low to no minimum balance requirements.
Different robo-advisors can have slightly different investment focuses and fee structures. For the DIY investor, one like M1 that allows subscribers to select several portfolio suggestions can be an excellent way to enter the investment game.
Tool #5 – Your 401(k)
An employer retirement fund is most people’s entry into investing. Employers typically match employees’ contributions, and most 401(k)contributions are pre-tax. This makes it an essential tool in your investor tool belt if you’re lucky enough to have one – and a good reason to maximize your contributions.
Older 401(k) plans often make investments on behalf of their members – usually in target-date funds. (Target-date funds have an age-dependent, predetermined mix of shares and bonds.) But modern 401(k) providers allow members to make their own investment choices out of a selection picked by the provider and employer.
Tool #6 – Tax-free/Tax-Deferred and Taxable Accounts
Don’t try to create your desired investment allocation in a single account. You should have multiple retirement and non-retirement (taxable) accounts and apply your allocation across all of them.
Tax-inefficient assets like REIT funds, high-turnover actively managed mutual funds, and high-yield bond funds should be sheltered in a tax-deferred or tax-free (Roth) retirement account.
Your taxable account should be reserved for investments made after you’ve exhausted your tax-advantaged options. The dividends and capital gains may be subject to taxes, but there are ways to minimize or avoid those taxes altogether.
Growth funds will be more tax-efficient than value funds because they have lower dividend yields. Fill your taxable fund with passive index funds (low turnover) and municipal bonds (especially tax-free ones.) This effectively replaces yield for a tax benefit that won’t be fully realized.
Tool #7 – A Donor-Advised Fund (DAF)
When it comes to charitable giving, it makes sense to make use of any tax benefits available. Donations to donor-advised funds (DAFs) give you an immediate tax deduction. This can be further optimized by contributing appreciated funds from your taxable account rather than cash. Capital gains tax will not be due by either you or the beneficiary.
Tool #8 – A Fun Fund
If you’ve chosen to be a DIY investor, the chances are you’re up for a bit of fun, no matter what your risk profile. Reward your caution by allocating a limited, small percentage of your portfolio to fun or “passion” projects. 5% is a reasonable number for most people.
You can use this money to invest in riskier stock than you would typically select, like private equity or penny stocks. Alternatively, you can put it towards hard assets that have particular meaning to you, like art, jewelry, or collectors’ cars.
Tool #9 – An Insurance Policy or Two
It would be a shame to spend all your time building up a successful investment portfolio only to lose everything through an unfortunate accident. Make sure you have the necessary insurance to prevent this.
Lower your premium costs by electing higher deductibles if you can afford them. And don’t cover (or even purchase in the first place) luxury items you can live without.
Tool #10 – An Investment Memorandum
Last but not least, draw up your investment plan or memorandum. This is a set of personal rules that will allow you to make the decisions you need to take consistently and swiftly.
They don’t have to be complicated. Do them on the back of the proverbial cigarette box/diner napkin or on an index card like Professor Harold Pollack’s, which went viral.
Please make a point of revising them annually; as your circumstances change, so should your investment focus. Marriage, the birth of a child, a promotion at work, or needing to take care of an aging parent are life events that could mean a change of direction is necessary.
Now that you have a well-equipped tool belt, you’re all set to go. A carefree retirement and freedom from the daily grind are within your reach. As always exercise good judgement and manage your risk well.
Image source: Blue Diamond Photography, via Flickr.
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